Significant Upside Materializing For Consol, Patriot Coal

Feb.22.12 | About: CONSOL Energy (CNX)

For investors looking to capitalize off of the rise of industrialization in emerging markets, CONSOL Energy (NYSE:CNX), Patriot Coal (PCX), and Arch Coal (ACI) are worthy of consideration. According to T1 Banker, CONSOL is currently preferred with a "strong buy" rating. Based on my review of the fundamentals, DCF model, and multiples analysis, I similarly find attractive upside in CONSOL.

From a multiples perspective, CONSOL is the cheapest of the three. It trades at a respective 13.6x and 11.7x past and forward earnings with a dividend yield of 1.3%. Arch Coal, on the other hand, trades at a respective 18.9x and 10.5x past and forward earnings with a dividend yield of 3.1%. To put this under greater context, consider that CONSOL is valued at only 56% of its historical 5-year average PE multiple!

At the fourth quarter earnings call, CONSOL's management noted fairly strong results:

Net income was $196 million or $0.85 per diluted share for the fourth quarter of 2011 compared to $104 million or $0.46 per diluted share for the fourth quarter of 2010. This is an increase of 88%. Total sales revenue for the fourth quarter of 2011 was nearly $1.4 billion. That's up 6% year-over-year.

For the fourth quarter of 2011, we generated operating cash flow of $275 million and EBITDA of $440 million. The primary driver for the quarterly results was the $17.95 per ton coal margins, which was an increase of 7%.

The company is well positioned with its large-scale operations in Northern Appalachia as trends worsen in Central Appalachia. Following the $3.5B acquisition of Dominion's (NYSE:D) gas assets, the company has become less of a coal firm than what investors acknowledge. Investors will benefit from high-risk adjusted returns by rejecting the myopic thinking of the market and backing natural gas, which will be driven by strong secular trends. Aside from natural gas, the company has excellent margins in coal as a result of its low-cost operations at longwall mines.

Consensus estimates for CONSOL's EPS forecast that it will decline by 10.3% to $2.71 in 2012 and then grow by 18.1% and 15% in the following two years. Modeling a 3-year CAGR of 6.8% for EPS and then discounting backwards by a WACC of 9% yields a fair value figure of $47.16, implying 26.1% upside.

Patriot Coal is a considerably riskier firm with 200% more volatility than the broader market. It has struggled to renegotiate contracts and recently announced that it will be idling 1.8M tons of production from its Big Mountain thermal coal plant. This announcement follows disappointing news that it was idling 5 met coal plants. Management, however, argues that it has flexible control over production and can easily tap operations when the demand outlook improves. Fourth quarter loss of $0.44 per share was far below consensus estimate for a loss of $0.28. The company guided for 27-29M tons of coal sales 7M tons of thermal exports in 2012.

Consensus estimates for Patriot Coal's EPS forecast that it will trend towards a loss of $0.80 in 2013 and then drop to a loss of $1.40 in 2014. With the bar being set low, however, investors have significant upside to reap from better-than-expected global economic growth.

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

Additional disclosure: We seek IR business relationships with all of the firms in our coverage, but research covered in this note is independent and prospectively commissioned. The distributor of this research report is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence. Always discuss investments with a licensed professional before making any financial decision. Statements made within this report may include “forward-looking statements” as stipulated under Section 27A of the Securities Act of 1933, Section 21E of the Securities Act of 1934, and the Private Securities Litigation Reform Act of 1995. Since these statements are uncertain, actual results may be materially different from those expected.