Met Coal Conundrum

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Includes: ANRZQ, CNX, MET, NSC, PCXCQ, WLT
by: Stone Fox Capital

Friday was a wild day in the metallurgical ((NYSE:MET)) coal sector as Patriot Coal (PCX), Walter Energy (WLT), and Norfolk Southern (NSC) all made noteworthy announcements. With Patriot Coal and fellow met coal producer Alpha Natural Resources (ANR) both sinking more than 10%, one would assume that all of the announcements were negative.

Summary of the announcements from Friday:

  • Before the market opened, Patriot Coal put a major damper on the sector by announcing the closure of several high-cost met coal mines due to slumping demand for seaborne coal.
  • During the day, Norfolk Southern announced the loading of the largest volume cargo in the history of Pier 6 at Lamberts Point.
  • After the market closed, Walter Energy announced a reduction in 2012 production due to equipment and facility issues while announcing the market remains robust. (Walter still expects roughly 19% to 34% production growth for the year)

Naturally the news for Patriot Coal is disastrous for the company. Yet another warning in a year full of missed opportunities to climb the met coal food chain.

For Alpha Natural though, the bulk of the news would appear mostly neutral. The ship loaded was for China indicating that demand might still be strong. The coal for the ship came from CONSOL Energy (NYSE:CNX) leaving in question whether Patriot Coal has other issues. Walter Energy still talked of a robust met coal market while the reduced production for 2012 only eliminates competition for Alpha Natural coal.

It's possible that the seaborne met coal market has hit a bump in the road especially with the high rupee in India making it very expensive for it to import coal. China has possibly slowed down as well. Does anybody expect these slowdowns to last?

One point that I have not seen addressed is that the U.S. might finally be entering a period of growing demand. Car sales are expected to rise next year and construction appears to have leveled off, which might finally lead to growth.

This might all set the stage for the emerging markets to return to strong growth by the 2H and for the developed markets to actually see increased demand for once, a combination that might test the supply markets.

Mineweb has a summary of a report from the Director of Coal for Hatch Africa. The director believes that an additional 300-million tones of crude steel will be produced per annum by 2015, leading to a possible supply deficit of met coal.

Supplies will be very reliant on Australia, but North America (read Alpha Natural) along with Mongolia, Mozambique, Indonesia, and Russia, will play major roles in filling that growth.

Alpha Natural remains the #3 global producer of met coal and an intriguing investment with the stock back close to the 2009 lows. As evidenced by the Walter Energy news, mining met coal isn't the easiest of tasks. Alpha has massive reserves and might not last long at these valuations.

Even analysts are divided on the announcements though only short term:

  • Deutsche Bank analyst Justin Yagerman in a note said the news confirmed "our cautious stance on the near-term met coal outlook given a mediocre economy and increased Australian met coal production."
  • Ted O'Brien, president of coal specialist Doyle Trading Consultants, said the market had largely misgauged the actual impact of Patriot's statement. Production volumes tied to Patriot's closed sites was "minimal," O'Brien said. "As far as the impact on the rails, today's announcement has little to none."

The whole sector has turned cheap with the end of 2011 sell-off, but the met coal producers remain the most attractive. After Alpha, Walter has appealing exposure to met coal though investors might want to wait until the new CEO is able to prove that a turnaround is at hand.

Disclosure: I am long ANR.

Disclaimer: Please consult a financial advisor before making any investment decisions.