Avery Schumer
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Goldman Upgrades Machinery Sector From Cautious To Neutral

A recovery in Chinese construction demand has led Goldman Sachs to upgrade Joy Global Inc. JOY and Caterpillar Inc. CAT to Neutral from Sell, while upgrading the broad machinery sector to Neutral from Cautious.


Analyst Jerry Revich is concerned about Joy's exposure to high-cost mining regions longer-term, but sees "potential for a capex recovery if the Chinese construction recovery continues."

"We estimate 70 percent upside to new equipment capex if spot commodity prices are sustained," Revich concluded.

The analyst raised his 2017–18 EPS estimates to $0.34/$0.38 from $-0.37/$-0.50, driven primarily by higher new equipment sales forecasts.

"We estimate $1.50 as mid-cycle EPS. Our estimate is based on new equipment sales of $1.2 billion – equivalent to 2014 levels and 100 percent above 2016E sales; and aftermarket sales of $2.0 billion – in-line with 2017E and 36 percent below 2012 peak," Revich said.

The analyst, who raised Joy's price target to $24 from $13, noted "stabilization in total mining capex budgets could be enough to drive normalization in equipment demand."

However, long term, Revich continues to see "market share risk for North American coal and iron ore due to significantly higher ore grades – and as a result lower costs – in Australia and South America."

According to the analyst, Joy "derives 16 percent of sales from Australia compared to Australia's over 40 percent share of seaborne iron ore and met coal markets."


On Caterpillar, Revich said a sustained China construction recovery has increased iron ore spot 20 percent higher since February, and could contribute to a recovery in machinery share of mining capex.

"Our Sell rating on CAT was based on our view of an extended downturn in US pipeline, global mining, and construction capex for commodity export countries. We cited improved commodity supply-demand balance and a weakening US$ as key risks to our call, which have played out as we did not anticipate a sustained China construction recovery," Revich noted.

The analyst, who expects mid-cycle resources sales of $7.1 billion compared to $5.9 billion in 2016E, said, "Incremental sales could come at 40 percent incremental margins." Revich raised his price target on the stock to $78 from $62.

However, he remains concerned about the gas compression capex cycle and still expects "the pace of U.S. pipeline capacity additions to slow, with a 45 percent decline in growth capex in 2017 compared to 2015 levels."

"We see a $300 million headwind in 2017 vs. 2016 EBIT, net of the impact of CAT's service business," Revich noted.