Joy Global (JOY) Module 4: Simple Analysis and Parsimonious Forecasting

1. Joy Global (JOY) Module 4: Simple Analysis and Parsimonious Forecasting Thomas Maguire 2/4/2014

2. Joy Global Background • Manufactures and services mining equipment • Focus on: Coal, Copper, Iron Ore, Oil Sands, and Gold • Revenue split between • Underground Mining Machinery • Surface Mining Equipment

3. Forecasting • Integral to a variety of business decisions • Value Stock • Financial statement forecasts • Creditworthiness • Cash flows forecast • Alternative Strategic Investment Decisions • Shareholder Value Creation • Our Use: • Transiti0ning from multiples method to theoretical models for valuations • Need to capture expectations for future performance- future financial information

4. Overview of Forecasting Process • Creating a Set of Financial Statements That Focus on Those Enterprise Items That we Expect to Persist • Reformulation to identify the sources of enterprise profitability • Mindset During Forecasting • Leaning towards conservative side- valuable opportunities can be missed • Could be just as costly as being to aggressive • Objective is to make the best possible forecast we can on given information • Precision • May appear more professional but not necessarily more accurate • Financial Forecast largely driven by revenue forecast

5. Overview of Forecasting Process • Forecast of Revenues, EPA, and NEA are linked in the same way as in our historical financial statements • Must link together within and across time • Must ensure forecast assumptions are internally consistent • Can’t: • Have large forecasted increase in revenue without a related NEA increase • Have a large increased gross profit margin during economic recession • Must be able to support all of our forecasts with compelling arguments • Want to have forecasts that are reasonable and consistent with the economic realities facing the firm

6. Return on Enterprise Operations • Measured as Return on Net Enterprise Assets • Using average NEA for Historical Analysis • Don’t know actual timing of investments • In forecasting setting, use ending NEA • Possible due to assumed timing of the investments by the debt and equity holders • Amount of resources employed varies throughout the year

7. Return on Enterprise Operations for Joy Global RNEA = JOY RNEA = JOY RNEA= 14.89%

8. Disaggregation of RNEA • As part of financial statement analysis, it helps to disaggregate RNEA into its two components: • Profit Margin • Asset Turnover • Allows us to see what is driving RNEA and gives insight into profitability of the company- very useful in forecasting

9. Disaggregation of RNEA • RNEA = • RNEA = • RNEA = • EPM- Enterprise Profit Margin • EATO – Enterprise Asset Turnover

10. Enterprise Profit Margin • EPM indicates how much operating profit the firm earns from each sales dollar • All things equal, a higher EPM is preferable • EPM is affected by: • Level of Gross Profit at the firm • Level of Enterprise Expenses required by the firm • Level of Competition • Affects product pricing • Willingness and Ability to Control Costs

11. Enterprise Profit Margin for Joy Global EPM = JOY EPM = JOY EPM = 11.39% For each dollar of sales during 2013 Firm earned roughly 11.4 cents profit after all enterprise expenses and taxes

12. Enterprise Asset Turnover • EATO measures the productivity of the firm’s enterprise assets • Reveals the level of sales the firm realizes from each dollar invested in enterprise assets • All things equal, a higher EATO is preferable • Can be increased by: • Increasing sales for a given level of investment in enterprise assets • Reducing the amount of enterprise assets necessary to generate a dollar of sales • Reducing Operating Working Capital Usually Easier than Reducing Long-Term Net Assets • Increase EATO • Have to be careful to not negatively impact sales or supplier relations • Level of Long-Term Net Assets determined more by the nature of the firm than by management action

13. Enterprise Asset Turnover for Joy Global EATO = JOY EATO = Joy EATO = 1.31

14. Net Enterprise Asset Analysis • Traditionally, we see EATO as more stable than EPM due to challenges in altering the assets required in generating sales • Observing a steeper decrease in EATO as opposed to a gradual decrease in EPM at JOY Global • For a manufacturing company, had abnormally high EATO in earlier years but has been rapidly increasing assets since • Drives down EATO and consequently drives down RNEA

15. Steps for Forecasting Process • No matter what level of detail we are employing in forecasting, a three step sequence is employed: • 1. Forecast revenues via forecasts of sales growth rates • 2. Forecast EPAT via forecasts of EMP and components of EPM • 3. Forecast NEA via forecasts of EATO • Forecasting the firm’s non-operating, financing, activities is not necessary • We are valuing the enterprise and then adjusting for the current value of the net financial liabilities to determine value of equity • Allows us to completely disregard forecasting future decisions on how the firm will be financed– determination of future leverage is avoided

16. Parsimonious Revenue Forecast- Industry

17. Parsimonious Revenue Forecast- Joy • Decrease over 2013 due to economic conditions, use weighted average, 50% 2013 and 50% prior three years, expecting a gradual “reversion to the mean” • Downturn we saw in 2013 was in line with the industry as observed on previous slide, strengthens reasoning for using 50% weight of 2013 in average • Assume sales growth rate of 3%

18. Parsimonious EPM Forecast • Focus on EPM from sales • Other components of EPM are not realistic to forecast, adjustments made for Joy: • Loss From Discontinued Operations • Change in Unrecognized Pension Benefits and Other Postretirement Obligations • Derivative Instrument Fair Market Value Adjustment • Foreign Currency Translation Adjustment • Allows us to see EPM from true value creation activities of the firm

19. Parsimonious EPM Forecast- Industry

20. Parsimonious EPM Forecast- Joy • See relatively stable EPM after adjusting to “From Sales” figures • Though Joy’s EPM is above the average of industry as observed on the previous slide, strategic management decisions and stringent cost reduction efforts will allow the company to maintain competitive edge • Assume EPM of 14.98%-- Average of last four years

21. Parsimonious EATO Forecast EATO forecast will help us to understand the resources that will be necessary to support the expected sales going forward Again, this figure is very dependent on the industry the company operates in

22. Parsimonious EATO Forecast- Industry

23. Parsimonious EATO Forecast- Joy • Again, EATO is rapidly declining but seems to have stabilized in last two years • This stabilization in the 1.99-1.31 range seems to put Joy more in line with competitors, making sense to exclude the very high 2010 and 2011 levels. The company’s specific focus on mining allows them to operate slightly above the levels of other competitors as noted on the previous slide. • Assume EATO of 1.65– Average of last two years which seem to be more of an indicator of reality in a manufacturing firm

24. Compiling Parsimonious Forecast • After analysis of Joy Global’s and competitor’s financial statements over the past four years, we have come to reasonable assumptions for the foreseeable future using parsimonious forecasting • Sales Growth Rate– 3% • Enterprise Profit Margin (EPM)– 14.98% • Enterprise Asset Turnover (EATO)– 1.65 • Using the assumptions above as inputs, we can forecast our expectations of Joy Global’s future Sales, EPAT and NEA

25. Joy Global 5 Year Forecasts of Sales, EPAT and NEA

26. Joy Global 5 Year Forecasts of Sales, EPAT and NEA Now that we have completed forecasting, we can use EPAT and NEA to obtain forecasts of free cash flow in Module 5!

27. Questions? Thank You!