2 Coal Stocks To Buy, 2 To Avoid

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 |  Includes: ACIIQ, ANRZQ, BTUUQ, CNX, WLT
by: Bidness Etc

Recent developments in the Coal Industry help us reiterate our previous thesis of expecting a rebound in thermal coal (possibly by the end of Q3 or a little later) and being a little cautious regarding metallurgical coal this year (as it is so highly linked to a pickup of the Steel Industry). The reason for being bullish on a potential thermal coal rebound is an increase in natural gas prices from record-low levels, in addition to the end of the hydropower season by the end of September. Metallurgical coal will start to rebound, but at a slower pace, because the industry is not only suffering from weak demand but also from oversupply issues. CONSOL Energy Inc. (NYSE:CNX) is our favorite player, despite its relatively expensive valuations, as it is a natural gas producer and has high thermal coal exposure. Peabody Energy Corp. (BTU) is also a good player for long-term investors who want to target a rebound of metallurgical coal. We are neutral-rated on Arch Coal Inc. (ACI) and Alpha Natural Resources (ANR), as a result of their poor operating performance despite cheap valuations.

Recent Developments

The global macroeconomic meltdown in general, and the slow economic growth in China in particular, had a devastating impact on the Steel Industry. As a result, its two major raw materials, iron ore and metallurgical coal, have also suffered severely. Iron ore prices are moving around three-year low levels, as Shanghai rebar (steel used in construction industry) futures hit their all-time lows recently. Likewise, spot prices for metallurgical coal have dropped from almost $225/metric tons two months ago to around $160/metric tons.

Recently, Consol Energy Inc. has decided to temporarily idle two of its metallurgical coal mines: Buchanan mine in Southwestern Virginia and at least a portion of Amonate Mining Complex in Southern West Virginia. The company took this step as a result of global oversupply of low quality metallurgical coal, which has resulted in a sharp price drop. The company said in a latest press release, "Global steel demand is under pressure and as a consequence, raw materials used to make steel are in less demand."

Consequently, the shares of coal companies experienced huge drops as illustrated in the following table.

Coal company

Share price drop (Yesterday)

Alpha Natural Resources

6.9%

Walter Energy Inc. (NYSE:WLT)

6.02%

Arch Coal Inc.

5.24%

CONSOL Energy Inc.

4.54%

Peabody Energy Corp.

3.37%

Click to enlarge

Source: Bloomberg

However, CNX's decision to idle its mines was not the only factor for such a huge price drop. It was also attributable to the cutting of investment ratings and/or price targets by Dahlman Rose & Co.'s analyst, Dan Scott. He downgraded ANR, BTU, and WLT from "buy" to "hold," citing their high exposure to weak prices of metallurgical coal prices, and cut ACI's price target. According to him,

"We are downgrading the three names with the most metallurgical coal exposure: Peabody Energy, Alpha Natural Resources and Walter Energy , to 'Hold' from 'Buy.' We do not think that the long-term met coal story is broken, but it will take the industry time to rebalance supply with demand."

Peabody Energy has also decided to close a mine in Indiana, as it feels that soft market conditions have made operations uneconomical. ANR and WLT have also announced production cuts before, as a result of low prices.

Investment Advice

CONSOL Energy remains our top pick, as its natural gas exposure makes it the safest coal stock. Furthermore, its most recent quarter's splendid performance and reasonable dividend yield make us recommend a long position in its stock. In addition, we consider BTU as the best stock to play a possible rebound in metallurgical coal prices, although its timing is uncertain. Still, its strong liquidity position, stable sales, and cheap valuations make it one of our favorites in this industry. Read our previous article for a detailed thesis on BTU.

We remain neutral on ANR and ACI as poor operating performance and the associated stock volatilities compensate their cheap valuations.

ANR

ACI

BTU

CNX

Forward P/E (1 year)

N/A

N/A

8.04x

15.58x

EV/EBITDA (NYSE:TTM)

4.08

6.49

5.46

7.51

Dividend Yield

N/A

2%

1.6%

1.7%

Share price performance (YTD)

-72.93%

-60.1%

-36.88%

-21.44%

Click to enlarge

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

Business relationship disclosure: The article has been written by Qineqt's Basic Materials Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.