The gradual increase in natural gas prices from their record-lows are making us bullish on a rebound in thermal coal in Q4. This recovery will be fueled by the end of the hydropower season by September, although potential defaults by key Chinese coal traders and high supply problems are slowing the rate of recovery.
Metallurgical coal's rebound is highly linked to a possible pick up of the steel Industry, which will ensure that demand growth no longer lags behind supply growth. This will bolster global coal prices, which are currently moving around their two-year lows.
Peabody Energy Corporation (BTU) and CONSOL Energy Inc (CNX) remain our favorite stocks in this sector. BTU's Australian assets' performed poorly, but the company is taking aggressive steps to decrease costs and improve productivity. In addition, it has no upcoming material debt maturities before 2015, and its liquidity position is quite lucrative. See our previous article for a detailed discussion on BTU.
CNX's financial performance is considerably better than its peers, primarily due to its exposure in natural gas, which makes it suffer the least from the ongoing trend of coal-to-gas switching. Arch Coal Inc (ACI) and Alpha Natural Resources Inc (ANR) need to be avoided because of their poor operating performance.
Alpha Natural Resources - Earnings Review
Alpha Natural Resources, the second-largest coal producer after BTU on the basis of revenues, reported its 2Q2012 earnings yesterday, according to which the company suffered a loss of $10.14/share, relative to last year's loss of 32c/share. This significant loss is largely attributable to the company writing off $1.5 billion in goodwill, and taking $1 billion as restructuring charges. After adjusting for such charges, the loss reduces to 33c/share, beating analyst expectations of 31c/share.
Its revenue has climbed by 13% as compared to the last year, as thermal coal prices started to improve recently. However, the company has reduced its coal shipment target range for 2012 from 100-116 million tons to 100-115 million tons.
Thermal coal, used for power generation, has suffered as a result of high stockpiles, mild winters, low-cost natural gas, and stringent environmental regulations. Consequently, its prices have declined by almost 20% on a YTD basis. Metallurgical coal, used for steelmaking, has also witnessed a demand dip, as the steel Industry is currently suffering from waning demand, low prices, and high stockpiles. According to the company, "The market is awash with lower-quality metallurgical coals, placing significant downward pressure on pricing."
The company's Chairman and Chief Executive, Kevin Crutchfield, said:
Previously, the company announced that it would shut down some mines at Kentucky and West Virginia, and slash production at several others to reduce output. The company said it might need to reduce its production targets further, citing "unattractive" pricing in the U.S. domestic and European export markets.
The company has become the largest metallurgical coal producer in the U.S., post its acquisition of Massey Energy Co. in June, 2011. However, the deal brought with it a host of acquisition charges and litigation costs.
ANR and ACI seem cheap on an EV/EBITDA basis, but their poor financial performance makes us recommend a neutral position. However, the other two players, BTU and CNX, seem better options if one is expecting a potential rebound in the coal sector in 2H2012.
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Share price performance (YTD)