For investors look to reap substantially high risk-adjusted returns, look no further than CONSOL Energy (CNX) and Arch Coal (ACI). These two companies - with betas of 1.5 or higher - are well positioned to gain from a recovery in the industrial economy. Based on my multiples analysis and DCF model, I find that both firms have attractive risk asymmetry.
From a multiples perspective, both CONSOL and Arch Coal are reasonably priced. The former trades at a respective 14.2x and 9.6x past and forward awnings while the latter trades at a respective 17.7 and 5.8x past and forward earnings. Arch Coal offers a dividend yield that is around 160 bps higher at 3.1%, but comes with greater volatility. While the Street is bullish on both companies, CONSOL is clearly preferred with its "strong buy" rating.
At the third quarter earnings call, CONSOL's CEO, Brett Harvey, exuded a level of confidence in the industry and that matters would turn around:
"We had a very active quarter, overall … The earnings and the increase in revenue, I think, show the strength of the assets and the focus that our people have on getting the job done. It's important that our shareholders understand that we are executing the strategy of bringing value forward to them as quickly as we can. After we did the deal -- when we bought E&P from Dominion, we announced to you that we would do that as fast as we could. We're bringing that value forward and I think we're positioned very well on both coal and gas for real growth and value for our shareholders".
What makes CONSOL attractive to so many analysts is that it produces at a favorable point on the cost curve. This 4th-leading producer of coal maintains high quality of assets, as well as a greater variety of high-margins products compared to its competitors. Furthermore, it owns logistical facilities that can support abnormal conditions in the export market, which remains challenging right now. As thermal and met coal prices are being challenged with U.S. CAPP thermal down 10% sequentially to $70/st, CONSOL is best positioned to hedge against disruptions.
Consensus estimates for CONSOL's EPS forecast that it will grow by 29.8% to $2.96 and then by 10.1% and 13.5% more in the following two years. Assuming a multiple of 14.5x and a conservative 2012 EPS of $3.19, the rough intrinsic value of the stock is $46.26, implying 37.1% upside. Modeling a CAGR of 17.5% for EPS over the next three years and then discounting backwards at a WACC of 9% yields roughly the same fair value figure at $46.26.
Moving onto Arch Coal, we find a company that has solid capacity despot poor third quarter results being well below consensus at an EPS of $0.08 versus $0.22. One-time longwall outage in Mount Laurel significantly reduced met coal production and will help driver higher risk-adjusted returns since it is not an assumed perpetual risk, per se. Finally, the company continues to show strong demand for Beckley and Sentinel.
Consensus estimates for Arch Coal's EPS forecast that it will grow by 4.4% to $1.19 and then by 88.2% and 19.2% more in the following two years. Assuming a multiple of 9.5x and a conservative 2012 EPS of $2.18, the rough intrinsic value of the stock is $20.71, implying 47.8% upside. Again, Arch Coal is yet another strong and safe "buy".