The coal markets have changed so significantly that it's very difficult to remember how bullish the market was on coal stocks early last year. Perhaps looking at two-year charts of Alpha Natural Resources, (ANR), Arch Coal, (ACI) or Walter Energy, (WLT) is as much a walk down memory lane as one can stand.
In looking forward, I found it useful to look at consensus earnings estimates from 1 year ago. For example, Peabody Energy's (BTU) consensus EBITDA estimate for 2013, (i.e. what the 2013 consensus was 1 year ago) was $3.1 billion. Today, the 2013 consensus is 41% lower at $1.8 billion. Back then, analysts expected Peabody's 2012 EBITDA to be a remarkable 31% above 2011's very strong showing.
Instead of up 31%, the current consensus suggests that 2012 EBITDA will be down 38% from 2011! That's a big swing and an even bigger surprise for investors, analysts and coal company management teams. Remember the coal, "super-cycle" that Peabody's CEO talked A LOT about last year?
Coal Company Margins May Never Reach 2011 Levels Again
Not only was 2011 a banner year for coal company profits, it was a year in which large acquisitions were made. Alpha acquired Massey Energy, Walter acquired Canadian producer Western Coal and Arch acquired east coast producer Intl. Coal. To say these deals top-ticked the market would be a gross understatement.
It's clear that 2011 was a peak earnings year for the industry and that profitability might not approach 2011 levels again for a long time, if ever. Note, I chose the words, "if ever" very carefully. Therefore, investors need to be realistic about how big a bounce they might see in coal stocks in coming months.
Comparing 2013 expected industry EBITDA to that of 2011, margins are forecast to be down an average of 35% (40% not including Alliance Resource Partners, (ARLP)). In short, investors are looking at negative growth next year, a still uncertain outlook for 2014 and higher debt levels. This will lead to lower, "normalized" earnings multiples for the group. Looking at today's valuations, the coal stocks are not particularly cheap.
Dreams of Coking Coal Prices of $400-$500 Per Metric Tonne
Think of it this way. The bullishness that existed early last year was largely predicated on very strong coking coal prices for 2012-2013, (say, $250-$350 per metric tonne) followed by long-term coking coal prices of around $225 per tonne. The icing on the coking coal cake was the possibility that long-term coking coal prices could average $250 -$300 per tonne! How could that possibly be?
Turning back the clock, consider this excerpt of a story from early 2011,
"Coking coal prices are tipped to reach US$500 a [metric] tonne as the floods across Queensland, Australia disrupt operations and limit supply, a research and consulting house says."
"Wood Mackenzie, which provides analysis on the energy and metals industries, says mines affected by the floods account for 55 per cent of Australia's total coal exports. The impact of the decrease in exports will be felt strongly in global coal markets," Wood Mackenzie said in a statement dated January 14, ."
"As the rainfalls have intensified, it is reasonable to assume that hard coking coal prices could reach between US$400 and US$500 per tonne."
Today, the thought of a long-term coking coal price above $250 per tonne sounds outright silly. But, Wood Mackenzie and a few sell-side analysts certainly gave currency to that notion. Current spot prices at about $160 per tonne are a far cry from $400-$500! It was that extra kicker, a, "super-strong" long-term coking coal scenario, that allowed investors to justify super-high price targets.
Fast forward 18 months and not only are long-term coking coal prices thought to be in the $170-$185 per tonne zip code, but the super-strong scenario is out the window, (for now). Equally important, robust volume growth is anything but assured, meaning unit costs are vulnerable even in a weaker pricing environment.
Anyone buying the coal stocks for a 2013 recovery is probably making a mistake. While the stocks could bounce back in coming months, fundamentals will remain weak well into next year. For me, I want to see some visibility on 2014, which is why I'm largely out of the coal stocks at this time. (I own Alliance Resource Partners and Natural Resource Partners (NRP) for their high distribution yields.)