As natural gas continues to get all the attention in the power sector, coal stocks continue their weakness. Recently, Peabody Energy (BTU) touched lows not seen since the Great Recession of 2008. The coal sector is not feeling any love at the moment, and now is the perfect time for contrarian investors to dig in.
The coal sector has been weak, when natural gas became cheaper than coal. That spurred utilities to switch over from coal as a power source to natural gas. Now that natural gas is back above $4 and likely heading higher, the economics for switching back to coal make sense. Look for coal demand to increase and profits to rise for coal companies on this increased demand.
In the metallurgical coal market, producers have had to deal with over-supply and a global slowdown. Steel demand has been particularly weak in Europe, and China's economy is not growing as fast as it used to. Couple that with new mines coming online, and you have a classic supply/demand imbalance. Look for the market to balance itself out later in the year.
Dividend Yield 1.80%
Peabody Energy is the largest private-sector coal company in the world. The company owns interests in 28 coal mining operations located in the United States and Australia. Proven and probable coal reserves total 9.3 billion tons. Its operations include mining thermal coal for power generation and metallurgical coal for steel companies.
Peabody Energy has a current market cap of $5.17 billion. The stock trades at a forward P/E of 11.69. The company just reported first quarter results where EBITDA came in at $280.1 million on revenues of $1.75 billion. The company lost $10.3 million compared to a profit of $183 million in the prior year. The main reason for the loss was lower U.S. shipments and lower Australian coal prices. Some highlights from this earnings report include:
"First quarter U.S. coal demand saw strong improvement over the prior year as generators switch back to coal and away from higher-priced natural gas in key regions," said Chairman & CEO Gregory Boyce. "We now expect that during 2013, coal will recapture the vast majority of its 2012 demand that was lost to natural gas."
Peabody expects global seaborne thermal demand to rise approximately 50 million tonnes in 2013 as approximately 75 gigawatts of new coal generation are scheduled to come on line. Over the next five years, over 450 gigawatts of new coal generation are projected to come on line, representing 1.4 billion tonnes of annual consumption at expected capacity utilization.
Urbanization trends in Asia are leading to continued growth in metallurgical coal demand. China is projected to have 15 to 20 million people move into cities each year over the next decade, requiring significant infrastructure investments. The company expects growing steel requirements to drive a 200 million tonne increase in global metallurgical coal demand by 2017, with Australia sourcing a significant amount of that growth.
Coal demand increased 8 percent in the first quarter and accounted for approximately 40 percent of total electricity generation. Natural gas prices are more than double prior-year levels, leading to gas-to-coal switching that drove an 11 percent decline in natural gas generation.
This trend accelerated in March, when U.S. coal generation rose 15 percent while gas generation fell 16 percent on higher natural gas prices. Peabody expects sharply favorable year-over-year coal demand increases to continue in the second quarter.
Peabody is targeting second quarter 2013 Adjusted EBITDA of $240 million to $300 million and Adjusted Diluted Earnings Per Share of ($0.25) to $0.01. Targets reflect expectations of increased Australian volumes and continued cost containment activities, partly offset by two longwall moves.
Of the analysts that follow the stock, 7 have it rated as a Strong Buy, 10 a Buy, 6 a Hold, 1 an Underperform, and 1 a Sell. Price targets for the stock range from $17 to $52 with $30 being the median target. The stock is down over 38% in the past year.
Alpha Natural Resources, Inc. (ANR)
Alpha Natural Resources is the world's third largest producer of metallurgical coal. The company produces, processes, and sells steam and metallurgical coal from 150 active mines and 40 coal preparation plants in Virginia, West Virginia, Kentucky, Pennsylvania, and Wyoming.
Alpha Natural Resources, like the other coal producers, faced a difficult 2012. According to the company's last earnings release:
Market conditions in 2012 were challenging for all coal producers, with reduced demand and over-supply in both the global metallurgical market and U.S. thermal market. In this environment, Alpha moved swiftly and decisively to reposition the Company for success. Alpha reduced its operating footprint, idling uneconomic and high-cost production; curtailed capital expenditures; streamlined its operations, with the expectation of reducing overhead expenses by an estimated $150 million annually going forward; and, enhanced its liquidity and increased its cash position. While the restructuring efforts announced in 2012 are largely complete, Alpha will continue to evaluate market conditions and remains poised to adjust as necessary as the industry continues to evolve.
Now that market conditions for metallurgical coal are beginning to point toward gradual improvement, Alpha expects to be well-positioned to emerge from the recent market headwinds as an industry leader and take advantage of opportunities in the market as they arise.
After a period of cyclical weakness in the global metallurgical coal market in the second half of 2012 during which approximately 30 million tons of uneconomic production was removed from the seaborne market, developments are beginning to point to gradual improvement. Chinese coking coal imports rose 30 percent from November to December 2012, reaching a record 7.6 million metric tonnes in the last month of the year, and full year 2012 coking coal imports were a record 53.6 million metric tonnes, a 20 percent increase over 2011. China's purchasing managers' index has been rising for several months and now stands at a 9-month high. Recently, tropical storms have hampered activity at Australian ports and disrupted rail shipments, although the impact is not as severe as the extreme weather events witnessed in early 2011.
In the Atlantic basin, European demand has been muted by economic headwinds, Brazil slowed its importation of coking coal somewhat in 2012, and U.S. demand has been generally stable. As a result, for the last several quarters, the Atlantic market has been characterized by market weakness and over-supply, particularly for lower quality metallurgical coals. Currently the Atlantic basin remains disconnected from Asia where the impact of production cuts and strengthening demand have begun to spark gradual improvement in the met market. Spot transactions of Australian met coal in Asia have reportedly risen above the recent benchmark price, and are some 20 percent higher than the low point in the spot market in September of 2012. As the leading U.S. producer of metallurgical coal, Alpha expects to be well-positioned to benefit from an eventual recovery in the global metallurgical coal market, particularly in the Atlantic.
Of the analysts that follow the stock, 3 have it rated as a Strong Buy, 8 a Buy, 12 a Hold, 1 an Underperform, and 1 a Sell. Price targets on the stock range from $7 to $16 with $11 being the median target. The stock is down over 55% in the past year.
Arch Coal, Inc. (ACI)
Dividend Yield: 2.50%
Arch Coal is the second largest producer of coal in the United States. Arch Coal has mines in Wyoming, Utah, Colorado, Illinois, West Virginia, Kentucky, Virginia, and Maryland. Reserves total 5.5 billion tons, of which 70% is low in sulphur.
Arch Coal has echoed similar comments made by the other coal companies. In their first quarter earnings release last week:
"Despite the global coal market headwinds that have prevailed over the last 18 months, we are delivering strong cost control, exercising capital restraint and minimizing cash outflows in the trough of the market cycle, while maintaining our commitment to safety and environmental excellence," said John W. Eaves, Arch's president and chief executive officer. "As the market cycle turns, we are confident that our low-cost operations will generate strong cash flows and value for our shareholders."
"Positive catalysts, such as normalized weather and higher competing fuel prices, are improving the outlook for the domestic thermal market, our largest market by volume," continued Eaves. "We expect these trends to continue to reduce customer coal stockpiles throughout 2013 and to create a more balanced U.S. coal market thereafter. Globally, we believe metallurgical and thermal coal markets are in the process of stabilizing, and we anticipate gradual improvement as we progress through the remainder of the year."
"The trend in U.S. coal markets is improving," said Eaves. "U.S. power demand is rising in 2013, coal production continues to rationalize, and coal is regaining its share of the domestic power generation market due to the higher cost or lack of availability of competing fuels."
Arch expects U.S. coal consumption for power generation to increase by 50 million tons or more in 2013 compared with 2012, due to favorable weather trends and higher natural gas prices. Coal supply rationalization also is expected to continue in 2013. Mine Safety and Health Administration data suggests that U.S. coal production totaled 246 million tons in the first quarter of 2013 compared with 268 million tons in the same quarter of last year. Increased demand and decreased supply should lead to a further liquidation in U.S. coal stockpiles in 2013. Internal estimates forecast that customer coal stockpile levels could end the year below 145 million tons.
"Looking ahead, we will continue to focus on managing through the market downturn with the liquidity that we have in place," continued Eaves. "We also expect a stronger second half in 2013, driven by improving domestic coal market fundamentals, a recovering metallurgical market and the startup of Arch's Leer longwall mine."
Arch Coal has a current market cap of $1.02 billion. Over the past year, the stock is down over 50%. Of the analysts that follow the stock, 4 have it rated as a Strong Buy, 5 a Buy, 13 a Hold, 3 an Underperform, and 1 a Sell. Price targets on the stock range from $3.50 to $12 with $6.25 being the median target.
Investors looking to get into the space must understand the commodity cycle. The same situation happened last year with natural gas when there was an overabundance and everyone thought that natural gas was dead. At $2, the headlines were that it was going to $1, some even said it should be given away. The coal sector is unloved at the moment. But as these 3 companies have said in their press releases, the cycle is turning. They have cut expenses and are positioned once the market turns. Remember that markets are forward-looking. The supply/demand dynamics are going to change in the coal sector by the end of this year. Now is the time for long-term investors to start building a position in these 3 stocks for when the market turns.