Are Coal Stocks Heating Up?

By Julian Murdoch

As coal companies begin reporting their earnings, how can you tell the stars from the stinkers?

• Why thermal vs. metallurgical matters
• Why Peabody's earnings were better than expected
• How to pick a coal stock

Taken as a whole, coal industry stock prices have done pretty well for themselves since January, and as Brad Zigler discussed in Oct. 19's "Time to Clean Up With Dirty Coal?", playing the Market Vectors Coal ETF (NYSE Arca: KOL) is a good way to trade the entire sector.

But sometimes investors want a more targeted approach, choosing one or more companies to invest in. That's the allure of stock-picking: Even in the best-performing sector, there will always be that one shining star - and that one stinker to avoid.

But as we enter earnings season, it can be tough to tell which is which, given that coal mining companies are expected to report lower year-over-year third-quarter earnings.

Ultimately, it may come down to the coal itself: Analysts have noted that how well and how quickly companies have recovered in Q3 will strongly depend on what type of coal they produce. Companies selling metallurgical coal, used for making steel, should see higher prices than those who produce thermal coal, used in generating electricity.

A Cruel Summer For U.S. Coal

Of course, in the United States, coal is mainly used for electricity generation; in fact, almost 50 percent of all electricity in the U.S. comes from burning coal. But since the recession has severely slashed industrial electricity needs, as a result, U.S. coal demand is down - way down.

Just look at these production figures from the latest EIA report:

That black line on the bottom is 2009, and as you can see, it has hovered below 2007 and 2008's production levels for most of the year. That's mostly due to intentional efforts by the industry; by shuttering mines and instituting planned production slowdowns, companies hoped to keep demand and supply in balance.

But the U.S. experienced a cooler summer this year, which led to less demand for electricity to power air conditioners. Complicating matters, low natural gas prices also helped tamp down coal demand, as electrical companies opted for the cheaper fuel.

So not only has less coal been produced this year, says the EIA, but stockpiles are at their highest levels since 1999. Compared with the previous three years, coal stockpiles are now 20 percent fatter:

It just goes to show that even though coal companies tried to contract, they just couldn't cut deep enough to match the drop in demand.

Consequently, U.S.-based Peabody Energy Corp (NYSE: BTU), which supplies about 10 percent of the thermal coal in the U.S., was expected to feel a pinch; some analysts projected earnings would fall to $0.22/share. But despite the dismal environment, Peabody, which released its Q3 results on Tuesday, exceeded expectations; even though earnings were still lower, the company posted earnings of 40 cents a share. Needless to say, the stock ended up on the day:

That's because Peabody isn't just a domestic supplier; with properties in Australia, the company was able to take advantage of demand outside of the U.S. Peabody's sales in Australia were 30 percent higher than in the second quarter, due to much higher volumes in seaborne thermal and metallurgic coal shipments ("seaborne" is just a fancy term for "coal shipped elsewhere"). According to the company's Q3 earnings report, it exported 2.7 million tons of metallurgic coal in that quarter - almost triple what shipped in the first half of 2009.

Three guesses as to where that coal is going - and the first two don't count.

Hungry For Coal: China ... And India

Recently, Australia has become China's top supplier of metallurgical coal (or "met" coal), beating out Indonesia. It's been a quick rise. In 2008, Australia exported just 1.1 million tonnes of met coal to China - a mere drop in the bucket, as far as China's concerned. But this year, things have been different; with just over two months left to go in 2009, Australia has already exported 14.5 million tonnes - making the country responsible for two-thirds of China's total met coal supply.

It's not all about steel though: China's also hungry for thermal coal. While the country was a net exporter of thermal coal in 2008 (to the tune of 7 million tonnes), now China has become a net importer - 38 million tonnes worth so far this year.

But down the road, India may be poised to surpass China in coal demand. The country is in the process of building new coal-based electrical generation plants that, according to Peabody Corp, will require approximately 175 million tonnes of new coal annually. With that kind of demand, India may become the fastest-growing coal importer over the next five years.

Which Coal Stocks To Play?

Coal companies well-positioned to meet China and India's growing demand will be the ones that benefit and recover first, and we're already seeing companies worldwide ramping up production.

Take Walter Energy Inc. (NYSE: WLT), another U.S.-based coal company, which also released its third-quarter earnings on Tuesday. Like Peabody, Walter Energy's earnings were down, but they also beat analyst expectations, with earnings of $0.44/share, vs. an expected $0.28/share.

Unlike Peabody, Walter Energy produces and globally exports metallurgical coal, and although production has slowed, sales are still ahead year-over-year. Because the company gets all its coking coal from the U.S., Walter Energy was able to beat the port congestion in Australia, and it expects fourth-quarter revenues to grow from increased demand from domestic steel mills.

Looking forward to companies yet to report their earnings, Anglo American Plc (AAUKY.PK) has several promising projects in the works. The company has planned some Australian-based projects that, if approved, could double its met coal output. At Anglo's South African and Colombian thermal coal properties, there are plans to increase output at a rate of 6 percent annually through 2018.

Xstrata (XSRAY.PK), the world's largest exporter of thermal coal, reports total coal production is up for the first nine months of 2009 to 69.4 million tonnes; last year's first nine months saw only 63.1 million tonnes produced. This increase comes even though its operations in South Africa are producing less, due to the planned shutdown of one mine there from reduced coal demand in South Africa's domestic market.

So what's an investor to do?

When picking a coal miner to invest in, look carefully at the type of coal, or mix of coal, the company produces; each has its unique demand forces. If you believe that China will power the recovery, you may want to go with a company producing a higher percentage of metallurgical coal. But if you're willing to hold for a bit longer, a company producing more thermal coal may allow you to benefit now from China's increased thermal coal imports, while setting you up for India's rise.

Or you can refer back to Brad's piece, and play the sector as a whole.

Comments

[tripleblack:]

Coal remains the bullseye commodity for the Cap and Trade environmental effort. Until the threat of Can and Trade is neutralized (or at least becomes a known variable with solid numbers to work with) this casts a long shadow over Coal.

Given the drawn out struggle over Health Care, I would say that Cap and Trade MIGHT slide until it impacts the event horizon of the 2010 elections, at which point it might be placed on hold until that election is thrashed out...

IF this occurs, or even if it becomes very likely due to delays in the political process, this might be a really good buy at that point.

Oct 22 05:38 PM

[bindlepete:]

Lot of coal for export piling up in Baltimore when I drove through today. More than I have ever seen before all north of the tunnel. I wonder who is buying? How much in Newport News or Southern Virginian seaports.

Oct 22 05:59 PM

[MJE_PDX:]

Why is it piling up?

1) They aren't selling it, but trying to keep some workers employed and are using it as a warehousing area?

or

2) They have sold it and it is going where?

Next time you drive by, could you stop and ask?


On Oct 22 05:59 PM bindlepete wrote:

> Lot of coal for export piling up in Baltimore when I drove through
> today. More than I have ever seen before all north of the tunnel.
> I wonder who is buying? How much in Newport News or Southern Virginian
> seaports.

Oct 23 03:32 AM

[Nav21517:]

Considering the amount of proven coal reserves worldwide, the lack of any alternative energy source to replace it, the worldwide need for a cheap electrical power fuel source and the fact that most of the world has committed itself to coal fired power plants, I find it hard to believe that anyone will be sitting in the dark to save the planet. The closest alternative would be nuclear power, but that conversion would take decades and even then, it comes with it's own set of nasty consequences. The simple fact that the world will never walk away from such an abundant coal resource only indicates that the answer isn't how not to use it, but rather how much effort we apply to develop a cleaner burning technology. Here in the states we view the world through rose colored glasses. Most of the rest of the world is poor and will opt for the cheaper energy producing fuel regardless of the global warming issue.

Oct 23 07:03 AM

[Grampa Jim:]

Thanks, Nav21517, for a brilliant perspective. And isn't technology in which we're so strong in the USA encouraging for a solution to the nasty side of coal? And are there not powerful economic and political forces pushing "clean enough coal" here and globally?

Oct 23 02:39 PM

[Nav21517:]

The technology to burn coal cleaner has been available for quite sometime, the problem is that it is rather expensive and the results are not as advantageous as they should be. Currently there are a number of large companies pooling their resources and in conjunction with the Dept of Energy to research further to develop yet a better more efficient process. As I stated before, worldwide there is plenty of coal reserves and there is no way we are ever going to walk away from it unless we discover some totally new power source. Here in the states we are referred to as the Saudi Arabia of coal. A more efficient and cost effective process will be discovered in order to take advantage of these reserves.

As far as powerful influences pushing the "clean enough coal" cry, there will always be forces on each side of the issue trying to push their agenda. The other side of that coin would lead you to believe we must tax the users of coal into submission to save the planet. They are most likely those most likely to gain from the "green" movement. You must realize that the only green many involved in the "green" movement really care about is the color of money flowing into their pockets. Cash for clunkers is a good example.

Global warming is a real issue, but the solution to achieving cleaner producing energy sources must include using petroleum based sources for many years.

Oct 27 02:51 AM

[Mark Anthony:]

Thanks for the article. Very insightful. Especially your mentioning of India's new demand of 175M tons of coal to be imported annually.

Try to expand your thinking a bit. All these new demand of coal importation means one thing: Sea bound transportation! Dry bulk shippers are what you need to play it. My favorites are EXM, EGLE, TBSI, DRYS etc.

Indian's new demand on coal is going to suck so much coal out of South Africa that it will lead to another electricity crisis of ESKOM, South Africa's electricity company. In early 2008 an electricity crisis in South Africa drive up price of two PGM metals, platinum and palladium dramatically.

Who stands to benefit? PGM mining companies outside South Africa. There are only two: SWC and PAL. Those are my favorites. Palladium is my favorite metal. I think history is going to repeat itself one more time. Watch any news on ESKOM.

seekingalpha.com/autho...

Oct 31 10:25 PM