I Remain Bullish On King Coal For 2014

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 |  Includes: ACIIQ, ANRZQ, BTUUQ, KOL, WLT
by: Equity Watch

Coal remains an important component of power sources and helps in maintaining a diversified energy portfolio. However, in the recent couple of years, coal has lost some of its share to natural gas, mainly due to lower natural gas prices and tougher environmental regulations, which led to a tough business environment for the U.S. coal industry. I believe the U.S. coal industry has bottomed out and coal markets will improve in the long term; therefore, I am bullish on the U.S. coal industry.

Last year, 2013, was a tough year for the U.S. coal industry as coal companies lost a significant amount of their market capitalization. However, it seems the worst is over for the industry, as rising natural gas prices and an economic recovery are portending well for the industry. Since the second half of 2013, the coal industry has been experiencing stock price appreciation and I believe U.S. coal stocks are poised well for a recovery in the long term, however, we might observe short-term stock price volatility. The following table shows the stock price performances of four U.S. coal stocks and coal ETF for 1H2013, 2H2013 and full year 2013.

1H2013

2H2013

Full Year 2013

Coal ETF (NYSEARCA:KOL)

(30%)

11%

(23%)

Peabody Energy (BTU)

(42%)

33%

(28%)

Arch Coal (ACI)

(51%)

22%

(40%)

Alpha Natural Resources (ANR)

(46%)

42%

(23%)

Walter Energy (NYSE:WLT)

(70%)

56%

(52%)

Click to enlarge

Source: Google finance

In recent years, difficult coal market conditions resulted in oversupplied coal markets and lower coal prices. In response to depressed coal market conditions, coal producers have cut their coal production, which portend well for the industry. Thermal coal markets have shown notable signs of a recovery, as monthly coal inventories at power producers are falling and coal-fired electricity generation is on the rise. On the other side, met coal markets remain slightly oversupplied; however, I believe more production cuts will be observed in the industry as we move forward, which will benefit the met coal markets in the long term.

Coal Consumption
Coal consumption in the U.S. has been on the rise in recent times, mainly due to a rise in natural gas prices. According to the Energy Information Administration [EIA], natural gas prices are expected to stay above $4 mmBtu in 2014, which I believe will make coal more cost competitive in comparison to natural gas and will result in higher coal-fired electricity generation. According to the EIA report, coal-fired electricity generation is expected to be up 5.4% year-on-year in 2013 and it projects another 190bps year-on-year increase in 2014. The following two graphs show the decreasing coal stocks and expected natural gas prices.
(click to enlarge)Click to enlarge
Source: eia.gov

Production Cuts
The tough business conditions that have persisted in the last two years for the U.S. coal industry resulted in oversupplied coal markets. Last year, ACI and ANR were the leading coal companies that observed production cuts. I believe the timing and magnitude of a recovery in coal prices still depends upon production cuts, and coal companies need to idle more coal mines to address the issue of oversupplied coal markets.

Last week, the EIA published its quarterly coal report, which shows that U.S. coal production during 3Q2013 stood at 256.7 mmst, representing a decrease of approximately 1% as compared to the corresponding period last year. For a sustainable and continuous coal price recovery, additional consistent production cuts need to be observed by producers. The following table reflects the quarterly U.S. coal production.
(click to enlarge)Click to enlarge
Source: eia.gov

U.S. Coal Exports
U.S. coal exports also remain an important driver for the coal industry. Since 2009, the U.S. has experienced a notable increase in coal exports. An improvement in economic conditions in Europe and other important markets will result in higher U.S. coal exports and will benefit the industry. In the recent third quarter of 2013, U.S. coal exports totaled 28.6 mmst, down 2.8% from 2Q2013. The EIA anticipates U.S. coal exports to total 107.4 mmst in 2014. The following graph shows recent export and import trends for the U.S.
(click to enlarge)Click to enlarge
Source: eia.gov

Conclusion
I believe the worst is priced in for U.S. coal stocks and coal will remain an important component of the energy portfolio in the future; therefore I am bullish on U.S. coal stocks, who remain attractive investment options for long-term investors. A rise in natural gas prices, production cuts, improvement in U.S. economic conditions and European economies, and healthy U.S. coal exports remain important drivers for the U.S. coal industry. Moreover, depressed current valuations for coal stocks support my bullish stance on the industry. I believe an improvement in coal markets will result in multiples expansion for coal stocks, resulting in stock price appreciation. The following table shows depressed valuations for the stocks.

Price-to-sales

Price-to-book value

BTU

0.7x

1.1x

ACI

0.3x

0.4x

ANR

0.3x

0.35x

WLT

0.55x

1.2x

Click to enlarge

Source: Yahoofinance.com

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.