On Oct 15, 2012 Consol Energy Inc (CNX) gave an earnings warning, and 10 days later reported a Q3 loss of $0.05 per share vs pre-warning consensus of a profit of $0.37 per share.
At the time of the Oct 25 earnings call, Nat gas futures stood just above $4. In fact they had reached their peak for 2012 just 3 days earlier. During the earnings call Consol management repeatedly referred to higher gas prices. Seeking Alpha's transcript of the call notes the following statements:
"favorable natural gas price trends"
"as we see gas prices rising"
"we think that $4 is probably a pretty good number, and we think gas prices are going to be over that"
"with the recent uptick of natural gas pricing"
"as gas prices continually trends up"
"caused obviously by higher gas prices as well as improved economic conditions"
"we do believe gas prices will strengthen"
"As the gas prices climb, as the futures climb because of increasing gas demand"
"So we think at the $3.75 gas and above, coal-fired units become base loaded again."
"with higher gas prices on the horizon, we're going to see a lot more coal burn in 2013."
However, Since that earnings call, Nat Gas prices have dropped significantly, falling 11% to $3.75 by Dec 31 (and falling even further into 2013).
Simply put, Consol's coal has to compete with Natural Gas as a fuel for domestic US power generation. Some of Consol's competitors such as Arch Coal Inc (ACI), Peabody Energy Corp (BTU) & Teck Resources Ltd (TCK) can benefit from any foreign demand for thermal coal and/or demand for metallurgic coal linked to demand in the steel industry. Consol however is flogging thermal coal suited for power gen, and it's mines are not as well positioned, geographically, for export so the company is very sensitive to Nat Gas prices.
With Nat Gas having fallen vs management's expectation for higher prices, I believe there is a good chance for a Q4 earnings warning next week.
The following mine capacity factors are considered when estimating upcoming Q4 earnings figures:
- in Q3 Bailey & Enlow mines suffered unexpected shutdowns due to equipment failures. Management reported these shutdowns negatively impacted net income to the tune of $53M, which is roughly $0.23 per share
- Buchanan mine, idled during Q3 has been brought online 5 days/week during Q4. It is dubious whether this mine will break even running part time so I'm estimating it's effect on Q4 earnings to be zero
Removing the $0.23 Bailey/Enlow impact from Q3's $0.05 loss and all else being equal we could expect a quarterly profit of $0.18 per share. However with coal futures having been on average lower during Q4 than Q3 I consider $0.18 to be a best case that will in reality not be achieved. We don't know the exact contracted prices and costs of production for each mine, but we do know that there was not much profit margin in Q3 with the higher coal prices, so there is potential for a profit much lower than $0.18 per share. Even a loss is not unimaginable. Consensus analyst estimate is current a profit of $0.21 per share, hence the possibility of a warning.
Combine this with Consol's falling recent and estimated earnings that have sent its P/E to an overvalued 35 and we have a short candidate.
If you're comfortable and experienced with shorting stocks, consider a short of CNX whenever Nat Gas is weak and valuation multiples seem high. My view is that right now is a good time for such a trade.
With domestic nat gas production on the rise, there is a case for shorting coal stocks in general as a long term trade, but CNX is singled out due to:
- Management basing earnings call guidance on higher gas prices that have not materialised and have instead since fallen.
- Consol's focus on thermal coal as opposed to metallurgic coal.
- Consol's geographic export disadvantage
- Consol's high forward P/E