Streetwise

Lauren Rudd

Sunday, July 7, 2013

Our Greatest Problem...Unemployment

Few will disagree that the recent equity market performance, despite some sporadic gains, has been erratic and unpredictable. Although the battle cries of rising inflation and soaring interest rates now ring hollow when bathed in the light of experience, there remains no shortage of prognosticators willing to tell you how much worse the future is likely to be.

Therefore, if you are wondering if Wall Street should be your street, you are not alone. Maybe the following will shine a bit of realistic light into that dark abyss we call the future.

The greatest problem facing the economy, corporate America and subsequently the financial markets are the ramifications resulting from an unacceptably high unemployment rate. Unfortunately, there is a willingness to either accept the problem as an intractable part of the economic landscape, or to reduce unemployment benefits in an effort to force the unemployed to choose between jobs at hand or face the horrors of poverty. This is bad economic policy.

Such prominent names as Yale economist Robert Shiller and Princeton economist Paul Krugman have been saying for months, if not years, a logical solution is for the Federal government to either hire workers directly for public services, just as it did during the Great Depression, and/or provide loans to the states for the same purpose, i.e., to rebuild the country’s infrastructure. The result would be increased economic activity, rising tax revenues, higher corporate profits and subsequently higher corporate share prices.

As commendable as such a program would be it is a long-term solution. Shorter term you need take advantage of the continuing uncertainty and market volatility and search for underpriced investment candidates likely to benefit long-term from the current ongoing but inexorably slow increase in economic growth.

One example might be Joy Global (JOY), a textbook example of a company badly damaged by the global economic decline and yet one that is positioning itself for an economic rebound. Joy engages in the manufacture and servicing of mining equipment for mineral extraction worldwide. A year ago my earnings estimate for its fiscal year ending October 2012, was $7.25 per share with a 12-month target price on the shares of $62. The shares back then were selling at $55.

The company earned $7.24 and the shares recently closed at $48.82, in the face of heavy short-selling. Short interest in Joy is up 13.29 percent since May 31 of this year. However, as recently as May 8, the shares were selling for $61.48. (A sell stop order would have been helpful here.) Why? The quick answer of course is disappointing earnings.

The mining portion of the non-residential construction industry has stagnated due to the difficulty in finding major projects. However, change is on the horizon. A report by Wells Fargo pointed out an upswing in sentiment surrounding the construction industry, specifically non-residential construction.

Despite its poor stock performance of late, Joy's profitability is improving. Moreover, Joy's net profit margins have been consistently above industry average over the last five years. A key reason is that Joy has targeted both research and development and acquisitions as key ways with which to improve profitability.

R&D has increased from $29.8 million in FY10 to $47.8 million in FY12. Furthermore, China is estimated to become the largest importer of coal by 2015. India is also looking at a similar upswing. To position itself to take advantage of the increased demand, Joy has managed to obtain substantial positions in Chinese coal producing companies.

Looking at the intrinsic value of the shares, a discounted earnings model produces a result of $72 using a 3 percent growth rate and a 15 percent required return. The more conservative free cash flow to the firm model produces an intrinsic value of $185.