Best Values In Coal Mining Group That May Outperform In A Recovery

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 |  Includes: ACI, ANRZQ, BBL, BTUUQ, CLD, CNX, JRCCQ, PCXCQ, TCK, WLT
by: GuruFundPicks

Most coal mining stocks had a banner day Wednesday, as the broader commodities group soared on news that the world’s central banks led by the U.S. Federal Reserve are coordinating their actions in boosting liquidity in a global effort aimed at easing Europe’s sovereign debt crisis. The coal mining group as represented by the Market Vectors Coal ETF (NYSEARCA:KOL) surged 7.2% for the day, with many coal stocks such as Patriot Coal Corp. (PCX), Alpha Natural Resources (ANR), and Peabody Energy Corp. (BTU), up more than twice the rise in the index.

The coal mining industry is cyclical and also extremely sensitive to changes in economic outlook, so market players were admittedly enthusiastic in pushing up prices even based on just increasing probability that the liquidity boost would ease the European debt crisis.

While it is too early to tell whether Wednesday’s surge signals the end of the commodities downturn, it is reasonable to expect that at some point coal demand and prices will rebound, and rebound big, based on both the inherent cyclicality of the industry as well as the influence of long-term demand drivers related to economic growth in China, India and the rest of the developing world. In this article, we test to see which coal mining stocks would outperform if coal prices rose back up to conditions we saw near the last peak in mid-2008. We based our analysis on not just forward P/E, but also price-to-book (P/B) ratio and the Enterprise Value to EBITDA (EV/ EBITDA) ratio. The EV/ EBITDA ratio is capital structure neutral, and is often used as an alternative and in addition to standard valuation measures such as P/E and P/B to compare across companies that have varying levels of debt leverage.

We determined, based on our analysis of the major coal mining stocks, that at mid-2008 during the last peak of the cycle, the average coal mining stock traded at a forward P/E of 30.4, at a 10.4 P/B and at 19.8 EV/EBITDA, as compared to current ratios for the group of 10.7, 2.6, and 7.1 respectively. Based on that (see Table), we determined that the following steel stocks would outperform when the cycle reverses itself and global demand and supply support higher coal prices:

Arch Coal Inc. (NYSE:ACI): ACI is engaged in the production of steam and metallurgical coal from surface and underground mines. ACI is undervalued, trading at a discount 6-7 forward P/E, compared to the average of 10.7 for the coal mining group, while earnings are projected to increase at 52.2% compound growth rate from $1.14 in 2010 to $2.64 in 2012. Also, it trades at a discount 0.9 P/B and 4.9 P/CF ratios, compared to averages of 2.6 and 11.2 respectively for the coal mining group. Furthermore, based on the calculated peak ratios, ACI can go up more than five-fold when the cycle reverses itself (see Table).

Teck Resources Ltd. (NYSE:TCK): TCK is a Canadian miner of coal, copper, zinc, molybdenum, gold and lead, mainly in Canada, the U.S., Chile and Peru. TCK trades at a forward 6-7 forward P/E, while earnings are projected to increase at 48.8% compound growth rate from $2.62 in 2010 to $5.80 in 2012. Also, it trades at a discount 1.2 P/B and 6.6 P/CF ratios. Furthermore, based on the calculated peak ratios, TCK can go up more than four-fold when the cycle reverses itself.

Walter Energy Inc. (NYSE:WLT): WLT is a producer of hard coking coal from underground mines for by the steel industry. WLT trades at a discount 7-8 forward P/E, while earnings are projected to increase at 9.6% compound growth rate from $7.41 in 2010 to $8.90 in 2012. Also, it trades at a discount 2.0 P/B and 6.8 P/CF ratios. Furthermore, based on the calculated peak ratios, WLT can go up more than four-fold when the cycle reverses itself.

Peabody Energy Corp. (BTU): BTU is engaged in coal production and sale through 28 operations in the U.S. and Australia. BTU trades at a discount 7-8 forward P/E, while earnings are projected to increase at 29.4% compound growth rate from $3.09 in 2010 to $5.17 in 2012. Also, it trades at a discount 1.8 P/B and 7.6 P/CF ratios. Furthermore, based on the calculated peak ratios, BTU can go up more than three-fold when the cycle reverses itself.

Cloud Peak Energy Inc. (NYSE:CLD): CLD is a producer of coal in the Powder River basin through three wholly-owned surface coal mines in WY and MT. CLD trades at a discount 9-10 forward P/E, while earnings are projected to increase at 13.6% compound growth rate from $1.72 in 2010 to $2.22 in 2012. Also, it trades at a discount 1.7 P/B and 4.6 P/CF ratios. Furthermore, based on the calculated peak ratios, CLD can go up more than three-fold when the cycle reverses itself.

Yanzhou Coal Mining (NYSE:YZC): YZC is a Chinese company engaged in mining, preparation, and railway transportation of coal, mainly in China. CNX trades at a current 8-9 P/E on a TTM basis, and at 1.9 P/B and 4.0 P/CF. Furthermore, based on the calculated peak ratios, YZC can go up more than three-fold when the cycle reverses itself.

The following coal miners would also fare well, however they would be challenged by current and projected earnings, and valuations, and they would be relative outperformers compared to the first group above:

Patriot Coal Corp. (PCX): PCX is a leading coal exploration and production company in the Eastern United States, with 14 active mining operations in Appalachia and the Illinois Basin. It is expected to generate higher losses going forward, from a 53c loss in 2010 to a projected $1.48 loss in 2011.

Alpha Natural Resources (ANR): ANR is engaged in the production, sale, and processing of coal from mines and preparation plants in VA, WV, KY and PA. ANR currently trades at a premium 12-13 forward P/E, and at a discount 0.6 P/B and 7.3 P/CF.

BHP Billiton Ltd ADR (NYSE:BBL): BBL is an Australian company engaged in the mining of base metals, iron ore, oil, gas, diamonds, and coals. BBL trades at a discount 9-10 forward P/E, while earnings are projected to drop from $7.83 in 2011 to $6.46 in 2013. Also, it trades at 2.7 P/B and 5.5 P/CF ratios.

Consol Energy Inc. (NYSE:CNX): CNX is a producer of bituminous coal and coal-bed methane gas primarily in the northern and central Appalachian and Illinois basins. CNX trades at a premium 11-12 forward P/E, while earnings are projected to increase at 28.6% compound growth rate from $2.22 in 2010 to $3.67 in 2012. Also, it trades at a discount 2.5 P/B and 6.3 P/CF ratios.

James River Coal Co. (JRCC): JRCC is engaged in the exploration and production of steam, bituminous and industrial-grade coal in KY and IN. JRCC currently generates losses, and it trades at a discount 0.5 P/B and 1.9 P/CF.

Table

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Click to enlargeDisclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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