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Andrew Liyana

Bucyrus International (NASDAQ: BUCY) manufactures mining equipment used to extract coal, copper, iron ore and gold. As such, Commodities Prices directly affect demand from Bucyrus's customers. When prices are high, companies like BHP Billiton (BHP), Peabody Energy (BTU), and CONSOL Energy (CNX) expand operations by buying new equipment sold by Bucyrus. A commodity bull run has helped Bucyrus's surface mining division increase sales at an annual rate of 22.36% over the past five years^[1].

In order to protect its revenue stream from the cyclicality of Commodities Prices and economic cycles, Bucyrus has expanded its "aftermarket sales" - service and support of existing equipment, including new parts - since re-emerging as a public company in 1996 (Bucyrus went bankrupt in 1994 due to rising debt interest payments and a slowdown in sales).^[2] These recurring revenue streams, often as part of a long-term contract, make swings in revenue less extreme. Bucyrus generated roughly 48% of its revenue from such services in 2007^[3].

Although the company is multinational (53% of sales were generated outside the United States in 2007)^[4], its portfolio is heavily concentrated in coal equipment, which accounted for 73% of machines sales during 2007.^[5] The large emphasis on coal, which accounted for a lower 53% of sales before acquiring DBT, makes Bucyrus vulnerable to fluctuations in coal production. While high oil and natural gas prices have promoted the use of coal, a shift away from its consumption and towards cleaner energy sources will have significant impact on Bucyrus's profits.

Business Overview

Prior to acquiring DBT on May 4, 2007, Bucyrus only manufactured surface mining equipment and sold related aftermarket services. By purchasing DBT from RAG Coal International for $731 million, Bucyrus added manufacturing capabilities of producing underground mining equipment systems^[6]. In December 2009 Bucyrus International(BUCY) agreeded to acquire the mining equipment business of Terex Corporation for 1.3 billion US dollars. This transaction further diversified Bucyrus International's already extensive portfolio of mining equipment by adding the world's largest hydraulic excavators, off-the-road haul trucks, highwall mining systems, and additional drilling machines and conveyor belt systems. As of 2008, the company divides its business into two segments - Surface Mining and Underground Mining.

Surface Mining

Accounting for 57% of revenue in 2007 (or $927 million), the Surface Mining division of Bucyrus manufactures draglines, electric mining shovels, and rotary blasthole drills. This equipment is used for extraction of coal (53% of segment's revenue), copper (23%), oil sands (12%), gold (7%), iron ore (3%), and other minerals (2%)^[7]. Of its customers, the largest, BHP Billiton (BHP), accounted for 9% of surface mining revenue, while the second through fifth largest customers were responsible for an additional 18%^[8]. Overall, Bucyrus generated 43% of the $927 million through new equipment sales, with the remainder being earned by selling aftermarket parts and services^[9].

Types of Surface Mining Equipment

1. Draglines are large crane shovels used to remove rocks and soil the cover coal. The expected life is 40 years, which makes obtaining aftermarket service even more important for generating future profits^[10].
2. Electric Mining Shovels help miners load material onto trucks. This equipment moves larger loads than its hydraulic counterparts, but is less maneuverable. Bucyrus places its expected life at 15 years^[11].
3. Rotary Blasthole Drills are used to drill holes for explosive placement, therefore, miners purchase this equipment when there is a need to break up rocks. The expected life of these drills is 15 years^[12].

Underground Mining

Using 27 sales and service centers, Bucyrus markets hydraulic roof supports, armored face conveyors, longwall shearers, and continuous miners to underground coal miners^[13]. Sales of new equipment accounted for 65% of this segment's $686 million revenue in 2007, while aftermarket repair and service generated $240 million in sales^[14].

Types of Underground Mining Equipment

1. Hydraulic Roof Supports help support mine roofs during coal extraction and have an expected life of 10 years^[15].
2. Longwall Shearer are used by miners to cut coal from walls. This equipment's expected life is 8-10 years^[16].
3. Armored Face Conveyors complement longwall shearers by removing material cut by this piece of equipment. Bucyrus reports an average life of 8-10 years for armored face conveyors^[17].
4. Continuous Miners last approximately 8-15 years and simultaneously cut material and load it onto conveyor belt systems^[18].

Overall Financials

Surface mining revenue increased 27% in 2007 compared with 2006 and improved market demand helped bolster gross margins^[19]. If one includes the acquisition of DBT, revenues grew 167%. Bucyrus had strong demand for new surface mining equipment and aftermarket service in 2007. Growth in underground mining equipment and aftermarket service orders were relatively flat, but picked up momentum towards the latter part of 2007^[20]. Bucyrus will spend approximately the same amount in capital spending in 2008 as it did in 2007 ($113 million^[21]). The company plans to increase manufacturing capacity in order to meet rising market demand. Bucyrus will complete expansion projects in Milwaukee, Edmonton (Canada), and Kilgore (Texas) during 2008. The mining equipment manufacturer will also add service facilities in Eastern Europe and Russia^[22].

^[23]

Geographical Sales Distribution

The portion of revenue being generated in the United States declined from 53% in 2005 to 47% in 2007 as Bucyrus expanded foreign operations^[24]. Bucyrus expects China and India to experience the most growth in surface mining demand^[25], and in to benefit from this demand, Bucyrus operates two Chinese manufacturing sites^[26]. Demand for coal in Russia remained strong in 2007 and Bucyrus hopes to increase its competitiveness with an additional two service centers in the area, which are set to open in 2008^[27].

^[28]

Key Trends & Risks

• Commodities Prices impact the demand for mining equipment. When commodities prices increase (usually during periods of strong economic growth when economic and domestic infrastructures are expanding and demanding more raw materials), mining companies expand operations due to the higher profit margins. Over the past six years, commodities performed well; Copper prices more than quadrupled^[29]and oil traded at $18 per barrel in 2002 but reached $100 in 2008^[30]. The strong performance extends beyond these two into other commodities. With the upswing in price, capital expenditures by mining companies grew rapidly between 2000 and 2006 as shown in the graph^[31]. Bucyrus faces specific commodity price risk (and reward) in coal, copper, and oil, because the equipment manufacturer sells mainly to mining companies extracting these three commodities.

• Coal is key to BUCY's revenues: Bucyrus generates roughly 73% of its annual revenue from coal mining customers^[32]. Production of coal shifts with economic and political factors. As oil prices rise, alternative energy forms become more attractive. Coal power substitutes natural gas and oil consumption in some instances, and therefore, the coal price tends to move higher also. But political actions can adversely effect the demand for coal, because politicians, in response to rising carbon emissions and acid rain, can impose taxes to curb its use or provide subsidies to other alternative energy that is cleaner. For instance, House Speaker Nancy Pelosi tried to push through a bill in December of 2007 that would mandate utilities to generate a portion of output with renewable energy sources.^[33] During 2007, demand for North American coal fell, which resulted in flat underground sale growth for Bucyrus^[34]. Nevertheless, the 2007 World Energy Outlook expects increasing coal infrastructure and high Oil Prices to boost coal demand from 4.1 billion tons in 2005 to 5.8 billion tons in 2015.^[35]

^[36]

• Copper also affects BUCY's balance sheet:Miners of copper form the second largest customer of Bucyrus (13%)^[37]. Prices of copper increased rapidly from 80 cents per pound in 2003 to almost $4.00 in 2008^[38] People use copper in electronics, cookware, fixtures, plumbing, and a variety of other items. The strong rise in copper prices boosted extraction of the material by miners, benefiting Bucyrus as it increased demand for equipment.
  

  

  ^[39]
• International markets are the key to Bucyrus's revenue growth. Bucyrus's international operations already account for more than 50% of the company's revenues^[40]. High infrastructure growth contributes to commodity demand in Russia, China, and other Emerging Markets. With the increasing demand, supply comes on board. Bucyrus continues to expand operations in these markets by constructing new manufacturing facilities and service centers.
• Bucyrus has expanded its aftermarket services division. The volatility of new equipment influenced Bucyrus to promote maintenance, repair, assembly, and diagnostic testing for mining equipment^[41]. This move increased margins and decreased the cyclical nature of demand for new equipment, because mining companies need equipment serviced even during flat production growth. Bucyrus can therefore benefit from growing demand in two ways - equipment sales, and new service contracts for this equipment. Mining equipment breaks down over time, and repair parts and maintenance are necessary. Further, large mining producers are increasing their reliance on outsourcing maintenance. Contracts typically cover 3-5 years and have renewable and early termination clauses^[42]. Aftermarket sales accounted for 47.6%, or roughly $768.5 million, of total revenue in 2007^[43].

Competition

^[44]

Bucyrus competes with other large international equipment manufacturers, such as Joy Global (JOYG), Terex (TEX), and Caterpillar (CAT). These companies compete for business not only on price, but on quality and reliability. Due to the large fixed cost of buying mining machinery (a dragline can cost $130 million^[45]), Bucyrus's customers will pay extra upfront to avoid costly downtime. Furthermore, these mining companies find local equipment service centers appealing, so that any necessary repairs can be made quickly. As a result, customers prefer to buy from equipment manufacturers with service centers not too distant from their mining operations. Bucyrus also helps customers avoid downtime by using a system of on-board monitoring controls that communicate with Bucyrus's service centers and help with troubleshooting.

In addition to competing with large global manufacturers, Bucyrus faces pressure from emerging local companies. The competitive pressure from small companies tends to be more for repair service and replacement units than new equipment^[46]. These companies, referred to as will-fitters, replicate Bucyrus's replacement products and sell them to mining companies at a discount. Bucyrus believes its superior quality, warranty agreements, and retention programs should maintain demand for its replacement equipment^[47]

Market Share and International Sales

This table^[48] compares sales and markets for large companies in the Farm and Construction Machinery Industry. For those companies operating in the mining industry, an extra column indicates each firm's global market share in the $17.7 billion market for mining equipment^[49].

^Estimates generated by the business segment of specified company include heavy equipment that can be used in highway construction in addition to mining. As a result, the actual market share percentage is likely lower.

References

1. ↑ Bucyrus (BUCY) 2007 Annual Report "Consolidated Statement of Earnings", Page 20
2. ↑ Answers.com
3. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Customers", Page 9
4. ↑ 2007 Bucyrus Annual Report, "Segment and Geographical Information", Page 55-56
5. ↑ Bucyrus Investor Presentation 3/6/08
6. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Acquisition of DBT", Page 5
7. ↑ Bucyrus Investor Presentation 3/6/08
8. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Customers", Page 9
9. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Customers", Page 9
10. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Original Equipment", Page 7
11. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Original Equipment", Page 7
12. ↑ Reuters Company Description
13. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
14. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
15. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
16. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
17. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
18. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
19. ↑ BUCY 2007 Annual Report, "Financial Summary", Page 2
20. ↑ BUCY 2007 Annual Report, "Financial Summary", Page 2
21. ↑ Bucyrus Investor Presentation 3/6/08
22. ↑ BUCY 2007 Annual Report, "Financial Summary", Page 2
23. ↑ BUCY 2007 Annual Report, "Consolidated Statement of Earnings", Page 20
24. ↑ BUCY 2007 Annual Report, "Segment and Geographical Information", Page55-56
25. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Customers", Page 9
26. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Underground Mining", Page 11-13
27. ↑ BUCY 2007 Annual Report, "Financial Summary", Page 2
28. ↑ BUCY 2007 Annual Report, "Segment and Geographical Information", Page 55-56
29. ↑ Kitco Metals
30. ↑ Wikinvest Concept: Oil Prices
31. ↑ US Government Census Data
32. ↑ Bucyrus Investor Presentation 3/6/08
33. ↑ Renewable Energy Law Blog
34. ↑ BUCY 2007 Annual Report, "Financial Summary", Page 2
35. ↑ Bucyrus Investor Presentation 3/6/08
36. ↑ National Mining Association
37. ↑ Bucyrus Investor Presentation 3/6/08
38. ↑ Kitco Metals
39. ↑ Kitco Metals
40. ↑ Joy Global (JOYG) Form 10-K, Fiscal Year 2007, "Geographical Distribution" Page F-41
41. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Aftermarket Parts and Service", Page 8
42. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Aftermarket Parts and Service", Page 8
43. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Customers", Page 9
44. ↑ Cover of Bucyrus's 2007 Annual Report
45. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Original Equipment", Page 7
46. ↑ Joy Global Form 10-K Fiscal Year 2007, "Competitive Conditions", Page 9
47. ↑ Bucyrus (BUCY) Form 10-K, FY 2007, "Competitors", Page 10
48. ↑ Collection of Form 10-K, Fiscal Year 2007, for each company in the table
49. ↑ Freedonia Group