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After a sharp decline in H1 2013, U.S. coal stocks managed to experience a strong rally in H2 2013. The strong performance by U.S. coal stocks in H2 2013 came as a result of cost curtailment efforts and reducing capital expenditure by U.S. coal companies. Also, improving the ending monthly coal inventories at U.S. electricity producers and rising coal-fired electricity generation supported the performance of coal stocks. I reaffirm my long-term bullish stance on U.S. coal stocks, as I believe coal will remain an important component of energy portfolios and any bad news has already been priced in. The following table shows the stock price performances of U.S. coal stocks in 2013.

Full Year 2013

H2 2013

H1 2013

Peabody Energy (BTU)

(28%)

33%

(42%)

Arch Coal (ACI)

(40%)

22%

(51%)

Alpha Natural Resources (ANR)

(23%)

42%

(46%)

Walter Energy (WLT)

(52%)

56%

(70%)

Coal ETF (KOL)

(23%)

11%

(30%)

Source: Google finance

In the ongoing tough coal market conditions, coal companies have efficiently managed to extend debt maturities in a bid to survive the industry downturn. Moreover, rising coal natural gas prices and better coal supply management will help in a recovery of coal prices. In recent months, thermal coal markets have shown more signs of a recovery than met coal markets, as an increase in coal-fired electricity generation helped thermal coal markets, while excess supply remains an overhang for met coal markets. The trend of an increase in coal-fired electricity generation is expected to continue as we move forward, which will benefit thermal coal markets; the EIA anticipates coal-fired electricity generation to increase by approximately 6% in 2013 and by 2% in 2014.

Coal companies have been curtailing their production in the last two years in response to excess supply in markets. In 2012 and 2013, U.S. coal companies reduced their supply by 79 million tons and 15 million tons, respectively (as shown in the table below). However, coal production in 2014 is expected to increase by more than 30 million tons, which I believe will be offset by a rise in coal demand. As we move forward, better supply management and a rise in coal demand will rationalize coal markets, which will portend well for coal prices and the coal industry. The following table shows U.S. coal production, coal exports, total consumption and ending coal inventories at electricity producers. (Data in the following table is in million tons).

Coal Production

Total Consumption

Coal Exports

Ending Coal Inventory

2010

1,084

1,048

81

182

2011

1,095

1,000

107

180

2012

1,016

890

125

192

2013

1,001

924

118

153

2014

1,037

955

105

152

2015

1,011

930

105

149

Source: eia.gov

Coal exports are expected to be better than EIA estimates, as coal exports from Hampton Roads increased by 2.7% in 2013. Also, ending coal inventories at electricity producers are dropping, which will benefit the coal industry.

As I mentioned above, coal companies have done well in improving their financial flexibility to navigate through the industry downturn. Most coal companies do not have significant debt maturities until 2018, which I believe is enough time for a recovery in coal markets. Therefore, I do not foresee bankruptcy or liquidity risk for any of the above-mentioned coal companies in the near-to-medium term. However, coal companies are expected to burn cash in a range of 0%-12% in 2014, and the situation is expected to improve in 2015-2016.

As we move forward, I believe ANR, BTU and WLT are the potential candidates who will indulge in asset sales and will restructure to further improve their financial flexibility and bottom line results. WLT has already announced that it will generate $250 million from the sale of assets in 2014, and BTU has been targeting the sale of non-core assets, which I believe will continue in the near term. Also, I believe cost control efforts of coal companies will continue in upcoming quarters.

Risks

Potential risks to my bullish thesis on U.S. coal stocks include lower natural gas prices and depreciation of the Australian Dollar. Lower natural gas prices will discourage the reverse coal-to-gas switch, which would negatively affect coal demand and create a hindrance in coal prices recovery. Also, any depreciation of the Australian Dollar will motivate Australian coal producers to accelerate their production despite the current excess coal supply.

Conclusion

I am bullish on U.S. coal stocks in the long term. Also, I believe that coal markets will improve in the future due to better coal management and an increase in coal demand. Moreover, coal companies have done well to lower their balance sheet risk by extending debt maturities, and efficiently lowering their cost curves. I advise investors to keep an eye on upcoming quarterly earnings releases of coal companies, where they are expected to disclose their production and cost guidance, which could affect their stock prices.

Source: Coal Industry Stays On Track To Make A Comeback