Eprioc Riding High As A Best-In-Class Play On Mining Capex

 

Writing on Epiroc (OTCPK:EPIRF) (OTCPK:EPOKY) in August of 2020, I thought that the shares already anticipated a mining capex recovery, “unless you believe miners are suddenly going to open the taps on capital spending,” and that’s exactly what has happened since. Strong metal prices have driven a strong early capex cycle for mining companies, with strength in key Epiroc markets like copper, gold, and iron, and the emergence of greenfield mining projects – the first such moves in about seven years. Beyond this near-term capex cycle, Epiroc is also well-leveraged to important trends in mining like automation and electrification.

I still believe that Epiroc has a serious claim to being the best mining company out there, but I don’t think it’s so good that it can support limitless rerating. Given the valuation and the recent share price moves, I’m more interested in names like FLSmidth (OTCPK:FLIDY) and Weir (OTCPK:WEGRY) now, but I’m not willing to step in front of present-day momentum in mining and risk getting run over by a short call with Epiroc.

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Eprioc Riding High As A Best-In-Class Play On Mining Capex

Epiroc In Good Shape Going Into An Uncertain Downturn

All in all, Epiroc (OTCPK:EPOKY) (EPI-A.ST) shares have held up surprisingly well through a period of significant uncertainty and pronounced weakness in equipment orders - and that was before COVID-19 swept around the globe. I thought Epiroc shares had okay, but not great, upside potential back in the summer of last year, after which the share rose more than 20% before a sharp selloff that led to a roughly one-third peak-to-trough move and a subsequent 30% rally. Over that period, Epiroc has been a relative standout, outperforming peers like Caterpillar (CAT), FLSmidth (OTCPK:FLIDY), and Komatsu (OTCPK:KMTUY), though admittedly none of those are apples-to-apples comps.

At this point I still like the company from a business quality standpoint, and the shares are down about 10% from the time of that last article. I expect significant declines in the business in the next couple of quarters, but longer term, I still see this as a quality mid-single-digit grower and a beneficiary of technology adoption across the mining industry. The prospective return isn't superior now, and investors may want to wait in the hope of another pullback, but I'd note that quality companies don't always give investors that ideal margin of safety.

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Epiroc In Good Shape Going Into An Uncertain Downturn

Epiroc Seeing Margin Leverage As OE Orders Fade

This is a tricky time in the cycle for heavy machinery manufacturers, and mining equipment manufacturer Epiroc (OTCPK:EPOKY) is no exception. Aftermarket demand remains healthy and service orders continue to rise, but original equipment demand is clearly fading from the year-ago recovery levels. Longer term, Epiroc is well-placed to benefit from increased miner interest in automation and electrification, and the company also has a meaningful margin leverage angle.

I believe the market more or less has this story priced correctly now. There’s an argument that Epiroc shares should be worth a little more on the basis of strong margins and returns (ROIC, et al), but on the other hand, my DCF-based approach suggests a high single-digit annualized return from here on the assumption of mid-single-digit revenue growth and high single-digit FCF growth over the long term.

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Epiroc Seeing Margin Leverage As OE Orders Fade

At Sandvik, Cycle, Value, And Self-Help Are In A Battle Royale

These are challenging times to evaluate almost any industrial company, but Sandvik (OTCPK:SDVKY) (SAND.ST) cranks that to “11” right now. In the plus column, Sandvik has done some very strong work with self-help over the past few years (streamlining supply chains, reducing overhead/fixed costs, culling low-margin business), and a lot of that improvement is acyclical. Sandvik is also benefiting from a strong recovery in mining capex, and has options to further remake the company through M&A. In the minus column, the cutting tool business looks to be rolling over and it’s tough to make headway when your largest, most profitable business is starting to struggle.

If a significant global slowdown is in fact underway (let alone a recession), it’s going to be tough for Sandvik to outperform. Still, I think Sandvik will manage some additional margin leverage from here while keeping its ROIC up in the 20% range, making this a very tempting name even now.

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At Sandvik, Cycle, Value, And Self-Help Are In A Battle Royale