I Am Bullish On King Coal

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 |  About: Peabody Energy Corporation (BTUUQ), Includes: ACI, ANRZQ, ARLP, WLT
by: Equity Watch

Summary

Rise in natural gas prices and coal-fired electricity generation will portend well for thermal coal markets.

Met coal market will benefit in long term due to better coal supply management.

BTU has strong and diverse asset base, and higher gross margin of 17%.

Coal has been an important component of global energy portfolios. However, in recent years, tougher environmental regulations, lower natural gas prices, and weak economic conditions of important global economies have adversely affected coal demand and stock prices of leading coal companies. I believe a rise in natural gas prices and an increase in coal-fired electricity generation will positively affect coal demand in the long term. Also, coal production cuts will portend well for a recovery in met coal prices in the long term. The following graph shows the stock price performances of Peabody Energy (BTU), Arch Coal (NYSE:ACI), Alpha Natural Resources (ANR) and Walter Energy (NYSE:WLT) since 2Q2011.
Click to enlargeSource: googlefinance.com

Coal companies have been making efforts to survive the Coal Industry downturn by cutting operational and capital costs. Also, coal companies have been extending debt maturities and selling non-core assets to navigate through the tough industry conditions.

In the near term, ongoing rail issues in PRB are likely to limit a recovery in thermal coal demand and prices. Once the rail issues are resolved, which are expected to start improving from 4Q2014 or the beginning of 2015, it will portend well for the thermal coal market. According to the Energy Information Administration [EIA], natural gas prices are expected to go above $4 mmBtu in the future, which will result in greater coal-fired electricity generation and higher coal demand. Also, coal-fired electricity generation is expected to increase to approximately 41% as compared to 39% in 2013.

On the other hand, excess coal supply has kept met coal prices weak. The quarterly met coal benchmark price for 3Q14 settled at $120 per ton, flat quarter-on-quarter. The met coal market is believed to be 5-10 million tons, despite production cuts of approximately 40 million tons in the last two years. I believe excess coal supply remains a significant hurdle in a recovery of met coal prices in the near term and met coal companies need to announce additional production cuts to address the issue of excess supply. The following chart shows the quarterly met coal benchmark price in recent quarters.

In the future, a rise in coal demand and consistent production cuts will positively help coal prices and the market. The following chart shows U.S. coal production, consumption, exports and ending inventory from 2012-2015. (Data in the table below is in million tons).

 

2012

2013

2014

2015

Coal Production

1,016

984

1,010

1,000

Total Consumption

890

924

951

924

Coal Exports

125

118

99

95

Ending Coal Inventory

192

154

132

136

Click to enlarge

Source: eia.gov

A Look into Coal Companies
As the Coal Industry conditions remain difficult, coal companies have been making efforts to lower their costs and cutting capital expenditures to support their bottom-line results and preserve cash. Also, coal companies have been closing their operations at high cost mines, which I believe will help them support their bottom-line results. Due to aggressive cost cut efforts, BTU, ACI, ANR and Alliance Resource Partners LP (NASDAQ:ARLP) reported better-than-expected EPS for 2Q14. The following table shows earnings surprises, and actual and consensus EPS estimates of coal companies for 2Q14.

 

BTU

ACI

ANR

ARLP

Actual EPS ($)

-0.28

-0.46

-0.56

1.37

Consensus Estimate ($)

-0.29

-0.49

-0.76

1.00

Earnings Surprise %

3.4%

6.1%

24.3%

37%

Click to enlarge

Source: Yahoo Finance

Due to a rise in natural gas prices, coal-fired electricity generation and coal production cuts, I believe coal markets will rebound in the future. Also, my thesis on a future coal market recovery is supported by analysts' EPS forecasts, as analysts are expecting EPS growth for coal companies in the coming years, as shown in the table below.

 

BTU

ACI

ANR

WLT

ARLP

2014

($1.15)

($1.87)

($2.70)

($6.76)

$4.62

2015

($0.05)

($1.16)

($2.12)

($3.73)

$4.99

2016

$0.53

($0.73)

($1.73)

($2.72)

$5.26

Click to enlarge

Source: Nasdaq.com

Conclusion
I believe coal markets are expected to improve in the future. A rise in natural gas prices and coal-fired electricity generation will portend well for thermal coal markets. On the other hand, met coal markets are likely to remain challenging in the near term due to excess coal supply; however, the met coal market will benefit in the long term due to better coal supply management. Also, I believe BTU remains the best coal stock to play a coal market rebound. BTU has a strong and diverse asset base. Moreover, BTU has a higher gross margin of 17%, as compared to its peers. Furthermore, BTU has lower debt to equity of 1.50x, as compared to ACI and WLT. The following table shows the gross margin and debt to equity comparisons between coal companies.

 

BTU

ACI

ANR

WLT

Gross Margin

17%

10%

8%

12%

Debt to Equity

1.50x

2.53x

1.09x

5.20x

Click to enlarge

Source: Yahoo Finance

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