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Industry Analysis: 3 Coal Companies That
Could Deliver Solid Gains
May 29, 2014 | About: ANR +0% ACI +0% BTU +0%
Investing in coal is a frightening proposition. The news coming out of
the industry is terrible, most of the companies are expected to post
net losses this year, and the sector's shares are down roughly 46%
since early 2012. But, even with the negatives, some positive factors
could make buying coal stocks a consideration. Such a purchase,
though not really an investment, might be an attractive measured
speculation.
Plenty of Bad News
The coal industry has been beset by bad news. President Obama's
plan to cut power plant emissions by reducing the burning of coal is just an example.
Though it might take years for his changes to go into effect, the trend seems clear. Demand
for thermal coal, that used to make electricity, is in secular decline. The ease of conversion
to cheap and abundant natural gas reinforces that trend. In 2012, a roughly 31% decrease
in natural gas price helped coal's share of U.S. electricity production drop to 37% from
42% a year earlier.
Lackluster growth in steel production has also hurt coal, a key steel-making component.
Production in Asia grew at a modest 3% in 2012, a sharp drop from historic rates, and
worldwide steel production rose a skimpier 1% due to reduced production in Europe. The
softness in international steel markets, in an ample supply situation, led to a serious price
decline for seaborne metallurgical coal. In the first quarter of 2013, pricing dropped about
30% compared to the year-ago quarter.
Some Hopeful Signs
As bad as the news is, some hopeful signs have emerged.
The three U.S. based companies I follow, Peabody Energy (BTU), Arch Coal (ACI) and
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Alpha Natural Resources (ANR), have all made efforts to rein in oversupply.
Peabody is limiting its 2013 capital spending to mostly maintenance on existing mines.
Arch has closed and idled production at various locations and took steps to control other
costs. Alpha Natural has suspended certain mining operations, which is expected to
reduce 2013 production by approximately 16% or 17 million tons compared to 2012 levels.
Global coal market conditions also improved during the first quarter. There was higher coal
consumption in the U.S. and a sequential quarterly increase in international seaborne
metallurgical coal price heading into the second quarter.
The most important positive factor for the industry was the quarters 12% increase in U.S.
coal use. This jump was due to higher electric power generation, driven by a colder winter
plus an increase in the relative cost of natural gas. Although increased demand didnt help
the coal industrys first-quarter results as utility customers drew down on flush inventories, it
should provide upcoming support. A reduction in coal stockpiles might foreshadow
increased sales and a reduced supply could imply better pricing. This combination might
help the industry post a surprisingly good future quarter or two.
Picking the Dog with the Fewest Fleas
To be frank, none of these coal companies should be viewed as a safe investment. The
goal is probably to find a reasonably attractive choice, based on price and safety, which
could benefit from a short-term improvement in industry fundamentals.
Peabody Energy is the worlds largest private-sector coal company with interests in the
U.S. and Australia. The company reported first quarter 2013 revenues of $1.8 billion and
adjusted earnings before interest, taxes, depreciation, depletion and amortization
(EBITDA) of $280.1 million. First-quarter revenues declined 14% on reduced U.S.
shipments and lower Australian pricing. U.S. revenues of $976.8 million decreased 12%
from the prior year, driven by a 6.0 million ton decline in shipments.
Peabody shares look fairly priced based on analysts' dismal 2013 expectations. Using a
cash earnings times a capitalization multiplier valuation, reasonable business value looks
around $12 to $13 a share at a slightly higher than average industry multiple range of 8 to 9
based on estimated revenues around $7.7 billion and average cash earnings of $396
million.
Arch Coal is another large coal producer, selling roughly 14% of the U.S. coal supply. It
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Comments
reported a net loss of $70 million in the first quarter of 2013, versus a net loss of $8 million
in 2012. Revenues totaled $826 million, down about $213 million from the prior year on
lower sales volumes. EBITDA was $84 million compared to $180 million a year ago.
Arch shares may look cheap, but they could be a risky proposition. Unlike its peers, the
company has not yet shown consistent free operating cash flow and it also has a very large
debt burden. Based on revenues of $3.6 billion and possible cash earnings of $133 million,
Archs fair business value looks around $5 per share at an average 8x multiple.
Alpha Natural Resources is the third-largest publicly traded U.S. coal producer, as
measured by its 2012 sales of $7.0 billion. The company reported a first quarter 2013
adjusted net loss of $104 million compared with an adjusted net loss of $58 million in 2012.
Adjusted EBITDA was $117 million compared to $210 million and sales were $1.3 billion
versus $1.9 billion last year. The 31% drop in revenues was primarily due to lower average
pricing and lower thermal coal volumes.
Alpha Natural's valuation might be attractive. Anticipating sales of $5.3 billion and cash
earnings of $260 million places the companys reasonable business value around $9 a
share, given the industry's average multiple of 8.
Conclusion
The coal industry doesnt have a whole lot going for it. But increased demand from utility
customers and reduced coal supplies could set the companies up for some surprisingly
decent results. Given the almost universal gloom surrounding the sector, any unexpected
good news may benefit shareholders. Although I would not consider them a true investment,
coal stocks might offer a reasonable speculative play.
Rating: 4.0/5 (1 vote)
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