Goldman Upgrades Machinery Sector From Cautious To Neutral

A recovery in Chinese construction demand has led Goldman Sachs to upgrade Joy Global Inc.

and Caterpillar Inc.

to Neutral from Sell, while upgrading the Machinery sector view to Neutral from Cautious. Analyst Jerry Revich, however, concerned about JOY's exposure to high cost mining regions longer-term, but see potential for a capex recovery if the Chinese construction recovery continues. "We estimate 70% upside to new equipment capex if spot commodity prices are sustained," Revich wrote in a note. 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 bn – equivalent to 2014 levels and 100% above 2016E sales; and aftermarket sales of $2.0 bn – in-line with 2017E and 36% below 2012 peak," Revich said. The analyst, who raised JOY price target to $24 from $13, noted stabilization in total mining capex budgets could be enough to drive normalization in equipment demand. However, in long-term, Revich continues to see market share risk for North American coal and iron ore due to significantly higher ore grades – and as a result lower costs – in Australia and South America. According to the analyst, JOY derives 16 percent of sales from Australia compared to Australia's over 40 percent share of seaborne iron ore and met coal markets. On Caterpillar, Revich said a sustained China construction recovery has increased iron ore spot 20 percent higher since February, and could contribute to a recovery in machinery share of mining capex. "Our Sell rating on CAT was based on our view of an extended downturn in US pipeline, global mining, and construction capex for commodity export countries. We cited improved commodity supply-demand balance and a weakening US$ 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 US pipeline capacity additions to slow, with a 45 percent decline in growth capex in 2017 compared to 2015 levels. "We see a $300 mn headwind in 2017 vs. 2016 EBIT, net of the impact of CAT's service business," Revich noted. On the sector, the analyst sees potential for mining equipment share of capex to return to historical average, implies a doubling in new equipment sales off 2016 levels. Revich also highlighted that the construction machinery demand in commodity export countries could improve if the current commodity recovery is sustained. "While capex/FCF is above the historical average, we note that if spot prices hold, earnings power for the major global miners would improve by 80% – a scenario that would take capital allocation toward capex to historical lows." That said, the analyst is not positive on the sector due to oversupply of Machinery in many regions of the world, "with pockets of pricing pressure." Revich's top picks in the sector include Trimble Navigation Limited

, WABCO Holdings Inc.

, Allison Transmission Holdings Inc

and PACCAR Inc

. In addition, Goldman still prefers Construction Products over Machinery and E&C, with Buy ratings on Vulcan Materials Company

, Martin Marietta Materials, Inc.

, and Summit Materials Inc

. http://www.benzinga.com/analyst-ratings/analyst-color/16/03/7763426/goldman-on-industrials-continues-to-prefer-construction- Shares of Caterpillar fell 2.36 percent to $76.48 and Joy Global dropped 2.09 percent to $20.14.