Forget Caterpillar: Buy its Top Competitor Instead

I can’t find another sector more hated than coal.

Most companies supplying the dirty fuel have been in a tailspin. Coal companies have underperformed the S&P 500 index by more than 30% over the past eight months. Some small-cap players like James River Coal and Patriot Coal are 80% below their 52-week highs.

After that kind of carnage, contrarian investors may be looking to buy coal companies here.

But there’s a smarter play…

Coal has taken such a huge collapse because natural gas has gotten so cheap. Natural gas is an alternative fuel to coal. Due to huge cost savings, utility companies are saving boatloads of cash by converting to the clean fuel.

Looking at the numbers, coal production in the U.S. is expected to fall to levels not seen since 1996, according to the Energy Information Administration. The massive decline in demand is forcing coal companies to shut down plants and curb production.

The decline in production has hit equipment manufacturers… like Joy Global (JOY).

Joy Global is one of the largest mining equipment manufacturers in the world. It essentially makes the machinery used to extract coal. It’s no surprise its stock has also pushed lower. It’s down about 15% over the last eight months.

But the moves aren’t necessarily related.

You see, Joy Global receives about 50% of its profits from places like Europe and Asia. Sure, these markets are seeing a slowdown. But natural gas prices are more than three times higher in these areas compared to America. In other words, over there, coal is still a much cheaper alternative for electricity generation compared to natural gas.

Coal fuels 70% of China’s electricity. In Europe, coal still accounts for the highest percentage of electricity usage (compared to nuclear, natural gas, wind, and solar). So coal is not going away anytime soon in these huge markets.

Joy Global is also a major supplier to companies that mine materials besides coal. Last year, mining companies spent over $140 billion to find new deposits of gold, copper, iron ore, and more, according to investment firm RBC Research. That’s 40% more than in 2010 – breaking a new record. I expect this number to move even higher in 2012, based on rising commodity prices.

Following its pullback, Joy Global trades at nine times earnings, a 30% discount to the S&P 500. But I believe the company should trade at a higher multiple than the large-cap index.

In July, construction giant Caterpillar closed its acquisition of Bucyrus. That’s Joy Global’s top competitor. Caterpillar paid $8.6 billion for the company, or roughly 18 times earnings. That’s twice the price Joy Global is trading today.

I am not expecting the company to be bought out at a 100% premium. But based on a comparison to Bucyrus, it’s significantly undervalued.

Joy Global has exposure to some of the biggest markets in the world. It also generates some of the largest margins in the business. Based on risk versus reward, I’d much rather buy Joy Global than any pure play coal producer.

Good investing,

– Frank CurzioSource: Growth Stock Wire

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