- The US coal sector moves in huge swing cycles, providing huge gains within short periods of time.
- A small percentage of supply/demand imbalances can tip the coal price either way. A small change in coal price can push the stocks to either extreme highs or lows. It was proven many times in history.
- The coal sector has limited inventory space. This forces quick rebalancing of supply and demand.
- Huge growth of international coal demand from China, India and Japan, and limited international sources for coal imports.
- The story of the natural gas glut was way over-blown. Same for the theory of weaker coal demand due to cheaper natural gas.
- A warm winter that depressed coal demand is behind us now. Coal production curtailments by US producers are dramatic.
- Current deep discount of coal stock prices is an excellent buying opportunity just like in the 2007/2008 coal rally. The previous rally was a small rehearsal. The new rally is a super bull cycle.
- There is a huge concentration of short interests in some coal mining stocks. The shorts have not studies the coal sector well. It will take a big short squeeze to resolve impasse.
- Shorts will lose their shorts for staying too long in their short positions. Longs will lose their profits if they sold their long position too soon. Some must get in. Some must get out.
In the previous coal rally, I bought James River Coal Company (JRCC) for $4.25, suffered the immediate plummet to $3.56, and sold it a few weeks later near $8. Why I did not buy back? It kept going up steadily and could care less I wanted to buy. JRCC topped $62.83 on June 20, 2008, gaining 1665% in 10 months.
I completely under-estimated the rally potential of coal stocks at the time. I thought about it deeply and gained valuable lessons. The unique supply and demand mechanism in coal makes the sector rally fiercely. It always goes up and down in violent cycles. It never stays at the bottom or lingers at the top for too long.
Luckily, the sector goes in cycles. So here we come having JRCC available again at $4.13 per share. It is wonderful that the history repeats itself and I do not have to repeat my mistakes this time.
More over, in the previous coal rally, the financial crisis was looming, and China was a coal exporter. Today, the financial crisis is mostly behind us. China's thirsty of water and energy turned itself into the world's No. 1 coal importer, with coal demand still growing at double digits. Amid criticism of environment and resource destruction, the authority vowed to cap the domestic coal production and encourage more imports.
China consumes about 4 billion tons of coal a year, imported 182.4M tons last year, a mere 4.5% of its demand. There is huge potential if the import percentage rises just a bit. China's Q1, 2012 coal import already jumped 88% over last year.
Do not expect Japan to stay in No. 2 in coal imports. Japan lost all its nuclear power stations due to the Fukushima nuclear disaster. It needs to import more coal to replace the power supply.
Are we forgetting India? India's population will soon exceed China's. India has no one-child policy. India is a more robust economy, with a political system more friendly to free market capitalism than the communist China. India has only 1/3 of China's land area and poor domestic coal reserves. It desperately needs to import more coal. It has vowed to take over China to be the world's No. 1 coal importer.
Within coal exporters, Australia is No. 1. But it will tax its coal miners heavily to limit exportation of its natural resources. No. 2 exporter is Indonesia, a country with a mere 0.6% of the world's coal reserves. It should be in the business of importing coal, not exporting it. They begin to realize that. They will impose heavy tax to limit their coal exports as well.
That leaves the USA, the world's No. 2 coal producer, as the only source all the international buyers of coal can count on.
Some claim the USA does not have enough infrastructures to handle higher volume of coal exports. That's not true! Last year USA could export 107M tons of coal. I looked up list of US sea ports. The top 12 sea ports handled 1221 million tons of goods in 2004. The top 100 ports handled a total of 2591 million tons of volume. We can export 200 to 300 million tons of coal with existing ports easily.
It can not be more bullish for the US coal sector. In the past rally, US coal producers were too eager to boost production. Thus they killed their own bull market each time.
This time, it is different. When the giant elephant and giant dragon comes to US coal market, I do not think US coal producers have the capability to boost coal production enough to kill the bull.
This will be an unprecedented US coal super cycle. It will have to be killed by demand destruction at the very end. That means coal prices will go to unthinkable high levels, and US coal producers will make an obscene amount of money, before the end of this coal super bull cycle. I am betting heavily on it.
If you have followed my coal and natural gas articles, you may feel disappointed at last week's US coal sector plummet in spite of a strong rally of natural gas price and recovering coal prices.
Don't get mad! Do get shares! JRCC would have much less to gain should it start the rally from $20 instead of from $4.13, right?
I say this to my fellow American Patriot Coal share holders:
Ask not what your stocks can do for you.
Ask what you can do for your stocks!
Ask not how low a stock can go before the rally starts.
Ask how high a stock can go at the peak of the rally.
My experience in JRCC said that it did not really matter whether I bought at $5, $4 or $3.75. It mattered where I sold. I sold at $8, very different from selling at $60. That was my regret. I never regretted not waiting a few more days to buy cheaper, did I?
So how much undervalued are US coal stocks? How high can they go up to? Let me use actual numbers to discuss.
The values of coal mining companies are in the coal, not in their bank accounts. The values are tied to coal prices. If coal price goes up $1 a ton, the cost is the same, but they earn $1 extra per ton of coal sold. So how much does $1 movement of coal prices affect the values of coal companies?
There are differences between metallurgical coal and thermal coal. But let's not get into those details or worry about balance sheets, debts, production costs of individual companies. Let's just look how much it benefits the companies, if coal price goes up $1, or $10, or $20 a ton, from current level.
The impact of coal price on a company's value can be gauged by these two numbers:
- Tons of coal produced in a year, per share of the stock.
- Tons of coal produced in a year, per $100 invested in.
The first number is obtained by dividing annual coal production by the number of shares outstanding of the company. It gives you an idea how much the share price should gain when coal prices go up.
When you further divide that number by current share price, it gives you a number that tells you how much coal production you get when you spend $100 to buy the company's shares at current stock price. This tells you how much a company's stock is under-valued. Higher number means you get more bang for you bucks.
Here are the results after I surveyed major public coal companies:
|Company||Stock Symbol||M Shares Outstanding||Stock Quote||Production in M tons||Per Share Production||Per $100 Production||Rank|
|Peabody Energy Corp.||BTU||272.260||$29.14||203.900||0.749||2.5701||8|
|Arch Coal Inc.||ACI||213.290||$8.08||151.500||0.710||8.7908||3|
|Alpha Natural Resources||ANR||220.020||$14.45||106.300||0.483||3.3435||7|
|Cloud Peak Energy||CLD||61.040||$14.27||98.700||1.617||11.3313||2|
|CONSOL Energy Inc.||CNX||227.550||$33.38||62.600||0.275||0.8242||10|
|NACCO Industries Inc.||NC||6.801||$106.71||27.900||4.102||3.8444||6|
|Alliance Res. Op. Partners||ARLP||36.880||$61.63||30.500||0.827||1.3419||9|
|Patriot Coal Corp.||PCX||92.900||$5.33||31.100||0.335||6.2808||5|
|Westmoreland Coal Co.||WLB||13.930||$9.35||21.800||1.565||16.7376||1|
|James River Coal Co.||JRCC||35.980||$4.13||10.300||0.286||6.9315||4|
|Walter Energy Inc.||WLT||62.471||$64.38||12.500||0.200||0.3108||12|
|Black Hills Corp.||BKH||43.929||$32.14||5.931||0.135||0.4201||11|
|TECO Energy Inc.||TE||215.805||$17.85||5.871||0.027||0.1524||13|
|BHP Billiton Ltd.||BHP||2660.000||$71.73||12,742||0.0048||0.0067||14|
Please pay attention to the second to the last column. It tells you how much coal production capacity you obtain when you spend $100 to buy the company's stock. This number is the higher the better. Last number is the rank based on this number.
Take Patriot Coal for an example. $100 divided by $5.33 per share buys you 18.76 shares, and 6.28 tons of coal production per year. If coal price gains $1 per ton, it boosts your share of the company profit by $6.28. If coal price gains $10 per ton, you are making $62.80 annual profit in your share of PCX. That's a lot of profit for $100 invested. What if coal price is up $20 or $50/ton?
If PCX makes $50 profit from each ton of coal, your $100 invested brings $50*6.28 = $314 profit each year, or $3140 in ten years.
Do you see how ridiculously under valued are coal stocks?
Is $50/ton profit margin of coal too much to ask for? Currently US Appalachian coal sells for $60/ton. The Chinese are buying lower quality coal for $127/ton. Europe is buying coal at $86/ton. The Brent crude oil price is trading at the energy equivalent of $450/ton of coal (one ton of coal = 4 barrel of oil). It is reasonable for coal to gain $50/ton. That price gain is only 2 pennies a pound ($0.02/LB).
Let's lower our hope to just $0.01/LB, or $22/ton profit margin for coal. Coal going up $22/ton from $60/ton is very moderate, isn't it?
Assuming a P/E ratio of 10 and $22/ton coal profit, $100 invested should bring $10 annual profit, which is 0.455 tons of annual coal productivity. Check out column 7 in the table above. The numbers are way above 0.455 tons, meaning they are hugely discounted.
These are production capacity you can buy with $100 and the potential of gains if they earn $22/ton from coal produced:
Coal Productivity (tons/$100)
Are you convinced to buy coal stocks yet? Recent strong rally in natural gas (NYSEARCA:UNG) is a strong signal that the rebound of the US coal sector is imminent. You can either bet that the coal sector will stay depressed for years despite of massive coal production curtailments, or you can load up now and sit tight for the rally to start. I bet we are days, not years away from a huge coal rally. I also bet that "sell (cover) in May, go away" is a better motto for the shorts.
Disclosure: I am long JRCC, PCX, ACI, ANR, BTU.