The Basic Materials sector led the way higher on Wednesday, and coal stocks have bounced well off their lows of the past few days. But the Dow has bounced nearly 760 points off Tuesday's low, so we must wonder if this rally will hold. Remember, this industry has seen its share prices plummet over the past couple of months, so this rally was coming eventually. Should you get in? Right now, I would say no, and here's why.
Coal stocks have been down lately as fears continue to build that we are headed into another recession. If so, industrial production will surely fall off, and the steel industry, which a lot of these metallurgical coal companies supply, will get hit hard. Despite stable coal prices currently, costs have been rising, which has been taking chunks out of margins, and this compression will only get worse if demand is hit. According to the Energy Information Administration, coal prices have been flat to up in recent weeks, although coal stocks have not performed as well. However, as you can see from this chart, average costs have risen to their highest levels over the past few years, and will be up 20% to 30% year over year. Now that we've look at the overall industry, let's look at some individual names.
Walter Energy (WLT): Walter Energy had a terrible earnings report last quarter as year over year costs skyrocketed, resulting in a 41% EPS miss. The company has now missed EPS expectations the past three quarters. Analysts have slashed 3Q 2011 estimates from $4.88 to $1.14 over the past 2 months. Over the same time, 4Q estimates have dropped from $4.47 to $2.65. Full year estimates for 2011 have come down from $15 to $8, and 2012 estimates from $16 to $10. A recent takeover rumor set the stock flying for a day, but shares quickly retreated. The stock recently hit its lowest levels since late 2009. Although it's popped nearly 20% off its recent low, it will remain under pressure as I expect more downward EPS revisions. This company needs to get its costs under control right now.
Alpha Natural Resources (ANR): Alpha has been the worst performing stock of the 6 names I will mention in this article, down almost 60% over the past 3 months. That would explain its 27% bounce off its recent low, surely there was a lot of short covering there. Like Walter, analysts have come down heavily on EPS numbers for both quarterly and full year estimates. However, Alpha is projected for one extra percentage point in revenue growth in 2011 and five more points in 2012 than Walter Energy. Alpha does not pay a dividend, while Walter is dishing about 1% right now. Alpha has a fair amount of cash on its balance sheet, which is about the only positive thing I can say right now. We'll check back on them in the coming months.
Peabody Energy (BTU): Peabody is one of the highly regarded stocks in thus industry, and analysts tend to prefer it over most other names. While this name doesn't offer the explosive 80% revenue growth this year like our past two contestants, if you take a look at the estimates page, you'll notice the EPS revisions have not been as bad as the others. And Peabody has been able to deliver, beating expectations in the past four quarters, unlike Alpha and Walter, who combined have only 2 beats. Peabody and ArcelorMittal (MT) are currently trying to acquire Macarthur coal to expand their coal interests in Australia, and it finally looks like they might get shareholder approval this month thanks to their sweetened bid. I like Peabody as their margins have not been hit as hard as others in the industry, and they maintain a very clean and improving balance sheet. This is a strong company, but at this point may be in the wrong industry.
Consol Energy (CNX): Consol has done the best of these six names over the past 3 months, but a 25% drop isn't something to cheer about. Consol has very good margins compared to the rest of the industry, but trades a little expensive on some of the valuation metrics. It is tied with Peabody for the highest ratings from analysts of this group of six. It also has seen the least damage when it comes to analysts slashing EPS estimates. Like Peabody, it has a very strong balance sheet, and I would say it's one of the best in the industry. But that doesn't give me enough to give it a buy rating at the moment.
Arch Coal (ACI): Arch Coal has almost a value play recently as it now pays a 3% dividend yield. Arch trails both Peabody and Consol in both operating and gross margins, but has a lower PEG ratio (projected 5 year earnings growth) and a lower price to sales (trailing twelve months) ratio. The company expects 39% revenue growth this year and 28% next year. The company recently slashed its 2011 full year guidance to a range of $1 to $1.40 from $1.75 to $2.15. The company, like a few others I've seen, blamed poor geological conditions that have interrupted mine operations. I haven't seen too much analyst reaction to this news, so I'd wait a week and see what the analysts do.
Cliffs Natural Resources (CLF): I threw this one in there because it has a similar coal business to those from above, but it's not 100% comparable because it does also do iron mining, which is the majority of its business. Analysts have cut quarterly and full year 2011 estimates by about 10%, but 2012 estimates have actually risen over the past three months. The short term liquidity of the company could use some improvement, but it's not a red flag yet. They've just spent a lot of cash recently to build up some of their longer term assets. Good for them. It should pay off in the long term, but I'm not sure about the short term.
The following table shows how these stocks have bounced nicely off their lows of recent days. This is not a good time to get in. If you wish to get in, wait for another pullback. With the Dow up 760 points in the last 2 days plus, a short term bounce is all that we've seen. This market will go lower before it goes higher. There are too many global problems right now, and that is bad news for this sector.
|Alpha Natural Resources||ANR||$15.49||$19.17||23.76%||-58.40%|
|Cliffs Natural Resources||CLF||$47.31||$58.89||24.48%||-37.66%|