Streetwise for July 24

Streetwise for Sunday, July 24, 2011

 

 

Streetwise

 

Lauren Rudd

 

Sunday, July 24, 2011

 

 

No Shortage of Prognosticators

 

 

Few will disagree that the performance of the equity markets, despite some recent gains, has been erratic, unpredictable and at times just plain not fun. Daily fluctuations of 100 or more points by the Dow Jones industrial average are all too common.

 

Even worse, there is no shortage of prognosticators willing to tell anyone who will listen (the media generally tune them in with rapt attention) just how much worse the future is likely to be. If all that negativism has you wondering if Wall Street is the street you should be on, maybe the following will help shine a bit of realistic light into that dark abyss we call the future.

 

Although the battle cries of disastrous deficits, failed stimulus programs and rising inflation ring hollow when bathed in the light of reality, hysterical voices of doom continue to flood the media. The message, repeated ad nauseauum, is that we cannot afford the unemployed, the poor, healthcare, Medicare and Social Security. Drastically reducing deficits and debt must take precedence. Failure to act will topple the economy, or so the bastions of conservatism tell us.

 

Instead of solving the problem, many in Congress are willing to accept high unemployment as being a structural and permanent part of the economic landscape — thereby condemning the unfortunate to the horrors of poverty.

 

The tragic part is that relatively simple solutions are readily at hand. As many economists, including Yale economist Robert Shiller and Princeton economist Paul Krugman have said repeatedly, one avenue of relief is that the government could hire workers directly for public services, just as it did during the Great Depression. In doing so we would see increased economic activity, rising corporate profits and subsequently higher corporate share prices.

 

So where does all this leave you? Again, the answer is an easy one? Search for investment candidates most likely to benefit from the inexorably slow but continuous economic growth. Consider for example Joy Global (JOYG). I used to include Bucyrus (BUCY) when I talked about Joy but in 2010 Bucyrus agreed to be purchased by Caterpillar for $7.6 billion, taking it off the table.

 

Joy engages in the manufacture and servicing of mining equipment for mineral extraction worldwide. A year ago my 2010 earnings estimate was $4.32 per share, with a 12-month target price on the shares of $74. The company earned $4.40 and the shares recently closed at $97.

 

The company’s second quarter results indicated that operating income increased by $54 million to $234 million, while operating margins improved from 20.1 percent to 22.0 percent when compared to the same period a year ago. The higher operating margin was due to price increases, improved overhead and a more favorable product mix.

 

A weaker dollar also helped, adding $22 million to net sales and $5 million to operating income. The company’s effective tax rate for the second quarter was 29.8 percent compared to 31.4 percent a year ago, the result of newly implemented tax planning strategies. The rate is expected to be between 31 and 32 percent for the full year.

 

Net income for the second quarter increased 34 percent to $162 million,. Earnings per share were $1.52 as compared to last year's $1.15 per share, despite a 1.8 million increase in shares outstanding.

 

Cash provided by operations was $257 million in the second quarter, as compared to $108 million a year ago. Inventories did increase during the quarter due to production expectations going forward. Capital expenditures were $25 million, as compared to $18 million last year and are expected to reach $130 million.

 

While history is all well and good, what counts is the future outlook. The intrinsic value of Joy’s shares, using the discounted earnings approach with an earnings growth rate of 17 percent and a discount rate of 15 percent, is $138. The free cash flow to the firm model yields an intrinsic value of $103, a bit low but in this case satisfactory given the growth rate.

 

My 2011 earnings estimate for Joy is $6.00 per share with a 12-month target price on the shares of $113 for a 13 percent capital gain. There is also an indicated dividend yield of 0.70 percent.