By Robert Gordon
Six months ago, most thought major coal producers would be doing well. What many did not foresee was a collapse in coal prices. There are two broad types of commonly mined coal: Thermal, which is usually used for energy production; and metallurgical coal, typically used in the steel making process. Historically cheap natural gas, EPA rulings and environmental concerns are turning U.S. energy production increasingly toward natural gas, causing thermal coal prices to fall. Europe's economic struggles have limited metallurgical coal demands, damping that market segment as well. In this harsh business climate, continued consolidation is likely. A thoughtful discussion of coal prices is found here. I will look today at four major coal producers to see how the price squeeze has affected their businesses, and how they are set up to prosper in 2012 and beyond.
Peabody Energy (BTU)
Peabody is the largest private sector coal company in the world. In fact, the coal that it mines accounts for roughly 10% of America's electrical production. It has a price to earnings ratio of 10.3, and a market capitalization of $9.8 billion, and pays a dividend of $0.34 annually, for a yield of 0.9%. Peabody laid an egg in the fourth quarter of 2011, posting earnings of $222 million, or $0.82 per share. While this was a modest 6% increase from the 2010 quarter, it fell far short of the mean analyst projected $1.33 per share. Most of the gap between reality and expectation had to do with unexpectedly cheap coal prices. Also contributing to the poor earnings report were costs associated with Peabody's acquisition of a controlling interest in MacArthur Coal. But since those results will be part of Peabody's income going forward, I include costs, equaling about 10 cents per share, here. Full year 2011 earnings came in at $958 million, or $3.52 per share. This total includes one time charges of about $0.24 per share. In 2010, Peabody earned $774 million, or $2.84 per share.
What is worse is that Peabody has served notice that during the first quarter of 2012, it expects earnings of only $0.50 to $0.75 per share. Sixty days ago, the mean analyst estimated first quarter earnings at $1.30 per share. Small wonder that Peabody is trading now for barely more than half the $61 per share it was at last summer.
Yet, the reasons why earlier projections has Peabody's 2012 earnings at over $5 per share are more or less still in place for the long run. Coal demand is growing in China and India in particular, and the MacArthur purchase will add to earnings in 2012 and beyond. I still believe the share price can double by 2014, and view the current setback as an opportunity. Aggressive investors take note.
Alliance Resource Partners L.P. (ARLP)
Alliance is a limited partnership engaged in the mining and sales of primarily thermal coal to utilities and industrial users. It is trading at a price to earnings ratio of 8.2. It has a market capitalization of $2.6 billion, and pays a quarterly distribution of $0.99 per share, for a yield of 5.4%. Of note is that Alliance has raised its distribution amounts each of the last 15 quarters. Alliance profits have increased now 11 consecutive years. In 2011, earnings came to $389.4 million, or $8.13 per unit. Fourth quarter 2011 earnings were $91.7 million, or $1.93 per unit. For comparison, over comparable periods of 2010 earnings were $321 million, or $6.68 for the year, Going forward, Alliance has already locked in prices for what may be 100% of its output for 2012, thus insulating itself from a coal price swoon. Analysts see earnings of $7.59 and $8.06 per unit in 2012 and 2013. I believe that 2012 earnings will be closer to $8.00 per share due to Alliance's broad hedging.
In its reports, Alliance management concedes that the coal price collapsed, and wants to take advantage of the fallout of that within the coal industry by increasing market share. In the long run, that is the right thing to do, and I have great respect for Alliance management. I think, with its yield and history, Alliance is a winning play for 2012 and beyond.
Arch Coal, Inc. (ACI)
Arch is a major coal supplier, specializing in domestic, low sulfur and metallurgical coal. It has a price to earnings ratio of 19.2, and a market capitalization of $3 billion. It pays a current quarterly dividend of 11 cents per share, for an annual yield of 3.1%.
Arch posted 2011 earnings of $141.7 million, or $0.74 per share. Adjusted for one time events, earnings were $205.2 million, or $1.07 per share. Adjusted 2010 earnings were $185 million, or $1.14 per share. The discrepancies of per share amounts are due to the earnings dilution occasioned by Arch's $3.4 billion, 2011 purchase of International Coal.
For 2012, Arch does plan to slow its production in response to softened demand. Analysts peg 2012 earnings at $1.06 per share, and I believe that may be a bit optimistic. The stock has fallen by 60% for a good reason, and I believe Arch picked an awful time to invest in its largest acquisition ever. I would urge you to avoid Arch.
Natural Resource Partners, L.P. (NRP)
National also is set up as a limited partnership, and it owns and manages several major mines in the United States. It does not actually do any mining. It takes royalties from the coal extracted from properties it owns. It has a price to earnings ratio of 25.2, and has a market capitalization of $2.7 billion. It pays distributions of $0.55 per quarter, for a yield of 8.5%. National was right on track in its fourth quarter and 2011 full year results. In the fourth quarter, before one time impairments, National reported earnings of $0.52 per unit. Analysts had projected $0.47 per share. For all of 2011, earnings excluding impairments were $1.99 per share.
But National is not immune from the effect of the marshmallow soft coal price market. Analysts, who had expected 2012 earnings at $1.93 per unit a month ago, have lowered their estimates to $1.76. Again, I believe that is optimistic, and at its current price to earnings ratio and with a PEG of nearly 15, I would avoid National.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.