FLSmidth Not Expensive, But Weakening Mining Outlook Is A Real Concern

As a play on the late-cycle mining sector, FLSmidth (OTCPK:FLIDY) (FLS.CO) has simply not worked since my June 19 article. In fact, this diversified supplier of equipment to the mining and cement industries has been among the worst performers of the mining stocks I follow, with Epiroc (OTCPK:EPOKY) the only name in the group I follow to outperform the S&P over that time period.

FLSmidth’s underperformance has been driven by multiple earnings downgrades, which in turn have been driven by weaker service uptake, mining project cost overruns, project delays, and weaker-margin mining orders working through the P&L statement. Although a bullish stance on FLSmidth could well be throwing good money after bad, and there are risks to the mining equipment demand outlook, FLSmidth appears to be trading at an undemanding valuation and a stronger global economy in 2020 would likely drive some rerating in this laggard.

Readers should note that the U.S.-traded ADRs are not especially liquid.

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FLSmidth Not Expensive, But Weakening Mining Outlook Is A Real Concern

FLSmidth's Underperformance Seems Overdone

I didn’t really like the prospects of FLSmidth (OTCPK:FLIDY) (FLS.KO) as a long-term hold back in September, but I didn’t expect a nearly one-third drop in the share price, nor the significant underperformance relative to other mining-exposed names like Epiroc (OTCPK:EPOKY), Metso (OTCQX:MXCYY), and Weir (OTCPK:WEIGY). In addition to concerns about an early end to the mining capex cycle, I believe the market has sold off FLSmidth on lingering angst over the company’s weak, low-margin cement business.

While the cement business looks like an “is what it is” situation for the foreseeable future, I think the market is too sour on the mining business and the company overall. FLSmidth is well-aligned with the mining industry’s push towards automation and productivity and I believe copper, gold, and coal prices remain supportive for the business. With the shares more than 20% below fair value, this is a name to consider, but the U.S. ADRs have lousy liquidity and if macro weakness spreads, it’ll likely pressure commodity prices and mining names in the near term.

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FLSmidth's Underperformance Seems Overdone

Strong Mining Markets Could Help FLSmidth Finish Strong

The mining sector has definitely recovered, but that doesn't automatically make every player in the mining sector a good pick. I wasn't too excited about the near-term trading prospects for Danish mining and cement equipment company FLSmidth (OTCPK:FLIDY) (FLS.KO) back in June, and I'm not surprised that the shares have been flat since then, while Epiroc (OTCPK:EPOKY), Komatsu (OTCPK:KMTUY), Caterpillar (CAT), and Metso (OTCQX:MXCYY) have headed higher on stronger orders and improving margins.

Although FLSmidth's second-quarter margins were oddly weak, the order recovery was solid, and there have seen been a lot of corroborating data points on the strength of the mining sector and the opportunities over the next couple of years for equipment supplies like FLSmidth. I don't find these shares cheap enough to have a lot of appeal as a long-term holding, but I think circumstances are setting up for a better performance for the shares in the last quarter of the year and more trading-oriented investors may want to take another look. For longer-term investors, visibility on better margin leverage would be/is a key gating factor to a more robust valuation.

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Strong Mining Markets Could Help FLSmidth Finish Strong

A Mining Recovery Has Boosted FLSmidth Far Enough

I always find it worthwhile to have an exit strategy in mind before ever entering a position, as it is sometimes easy to get carried away when an idea is working out. To that end, FLSmidth (OTCPK:FLIDY) has developed better than I'd expected as short-term play on a mining equipment recovery, with the shares up about 15% since my January write-up even after a roughly 10% decline from a near-term high.

Although there are potential drivers of even better performance and FLSmidth's valuation isn't bad relative to many other industrials, I'm not inclined to get greedy. So, while mid-single-digit revenue growth and margin improvements can still support a high single-digit total annualized return and I believe mining orders still have room to surprise to the good, I don't see enough upside to continue pushing this as a buy idea.

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A Mining Recovery Has Boosted FLSmidth Far Enough

FLSmidth Should See A Sharper Recovery In 2018

Like its peers in the mining capex space, FLSmidth (OTCPK:FLIDY) (FLS.CO) has already seen a sizable recovery in its share price from the worst lows of the cycle, but there should be more in store as orders improve in 2018, and the company benefits from meaningful operating leverage. Although FLSmidth has exposure to a still-challenging cement market that other mining companies like Metso, Outotec, and Weir don't have to contend with, I think it is notable that FLSmidth has management to get this business close to breakeven even at historically weak levels of activity.

The cyclicality of FLSmidth is a major issue when it comes to considering these shares as a long-term holding, but that cyclicality can nevertheless benefit shareholders in the near term. If mining equipment orders and revenue continue to strengthen through 2018, I believe these shares can outperform with 10% or more upside from here in the short term.

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FLSmidth Should See A Sharper Recovery In 2018

Atlas Copco's Excellence Reflected In The Performance

Sweden's Atlas Copco (OTCPK:ATLKY) is a case in point as to some of the limitations of modeling and model-based valuation. This is an excellent industrial conglomerate by almost any standard and one that is well-respected and generally well-liked. When I last wrote about the company in September of 2016, I liked the company quite a bit but thought that the valuation was already very healthy. Since then, not only have the company's underlying markets come back faster and stronger than expected but so too has investor enthusiasm - pushing these shares up by a third, in line with other strong Swedish plays like SKF (OTCPK:SKFRY) and Sandvik (OTCPK:SDVKY) but well ahead of strong U.S. industrial conglomerates like Fortive (NYSE:FTV) and Illinois Tool Works (NYSE:ITW).

It's hard to connect the dots on the valuation today, unless you think long-term revenue growth will reach the high single-digits, FCF margins will move into the 20%s, and/or you're willing to accept a total return closer to the mid-single digits. I've learned over the years not to bet against Atlas Copco (or at least to do so very carefully), but even the company's announced split and ongoing recoveries in multiple markets can only do so much for a stock that already enjoys quite a bit of esteem.

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Atlas Copco's Excellence Reflected In The Performance

Seeking Alpha: FLSmidth Doing Better Than Expected Through The Trough

I may have been right about the serious impending erosion of orders, revenue, and EBITDA at FLSmidth (OTCPK:FLIDY) when I wrote about the company in June of 2013, but I missed the extent to which investors would cheer the company's cost-cutting and return improvement efforts. With the shares up 30% over the past year in U.S. dollars (and about 10% in the local Danish kroner), FLSmidth has handily outperformed most of its mining capex peers like Outotec (OTCPK:OUKPY) and Metso (OTCQX:MXCYY), as well as Joy Global (JOY).

I continue to believe that FLSmidth is looking at some challenging times in its end markets. Mining capex continues to fall and the company is facing more competition and consolidation in its large cement operations. Bold (but achievable) cost-cutting targets lead to me to a higher estimated fair value, but I have my doubts as to the company's ability to offset order declines with lower costs. Should orders continue to come in better than expected, though, and/or if the cycle isn't as bad as feared, FLSmidth's leverage to capex spending could send the shares higher.

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FLSmidth Doing Better Than Expected Through The Trough

Investopedia: Winter Still Coming For Joy Global

Cyclical industries have a habit of answering the question “How much worse/better can things get?” in pretty dramatic fashion. With mining companies slashing capex budgets left and right, winter is definitely coming for leading mining equipment company Joy Global (NYSE:JOY). While management's success in streamlining operations, improving manufacturing yield, and reducing fixed costs should keep the company's head attached firmly to its body, there's a risk to shareholders that the market hasn't fully digested what weak orders today will mean for tomorrow's revenue. So although I believe Joy Global is undervalued on a long-term basis, investors buying or holding today have to be able to tolerate the thought that the shares could have further to fall before stabilizing.

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Investopedia: Cemex Looking For U.S. Prices To Get Firmer

There aren't too many commodities more leveraged to construction activity than cement, which is both good and bad news for Cemex (NYSE:CX). A major player in the cement and ready-mix concrete markets in the U.S., Mexico, and Europe, Cemex has been buffeted by the severe downturns in the U.S. and Europe. With a debt restructuring providing more breathing room and a focus on “value over volume” in the U.S., Cemex could have some room to trade higher on optimism about a U.S. housing recovery.

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Seeking Alpha: Without Emerging Market Growth, FLSmidth Stuck In Cement

China's break-neck infrastructure development over the past decade seriously distorted multiple commodity and resource markets, and now companies are scrambling to figure out what the "new normal" actually is. Companies like Caterpillar (CAT) and Joy Global (JOY) have been fairly circumspect with guidance, and major miners like Rio Tinto (RIO) and BHP Billiton (BHP) have been pulling back on their capex plans.

That brings us to FLSmidth (FLIDY.PK) - a global engineering company that provides an array of equipment and services for the cement and mining industries. Barring a significant re-acceleration in demand for cement, coal, and base/industrial minerals, it's hard to see why this company deserves a higher multiple.

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Without Emerging Market Growth, FLSmidth Stuck In Cement