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In the Coal Industry, we continue to recommend those companies that have a relatively high exposure in thermal coal, as opposed to metallurgical coal, which is suffering from depressed market fundamentals. We reiterate our buy recommendation for CONSOL Energy Inc. (NYSE:CNX) and Peabody Energy Corp. (NYSE:BTU), in a descending order of preference. We recommend avoiding Arch Coal Inc (NYSE:ACI) due to its comparatively weaker balance sheet and high beta. We are neutral on Alpha Natural Resources (NYSE:ANR) and Walter Energy (NYSE:WLT) due to their high exposure in metallurgical coal, despite cheap valuations.

Thermal and Metallurgical Coal

Both main types of coal, thermal and metallurgical, suffered from different market dynamics this year. While thermal coal was affected by a shale gas boom, which resulted in a coal-to-gas switching trend, metallurgical coal (used in steelmaking) suffered as a result of sluggish global economic growth, which led to poor demand for steel. As the fundamentals stay weak, we remain skeptical about a rebound in the short term as far as metallurgical coal is concerned. However, we are bullish on a recovery in the long term as global economies continue to take measures to bolster economic growth.

In the short term, we continue to remain bullish on thermal coal, which is used for energy generation. We feel that the industry has reached an inflection point. This is because natural gas prices have begun to rebound, companies are cutting production, and exports are increasing. All of these factors will eventually lead to an improvement in thermal coal prices in the short term.

Investment Advice

Companies that are more inclined towards metallurgical coal are trading at relatively inexpensive valuations due to poor stock performances this year. However, as we remain skeptical about the commodity in the short term, we recommend staying away from companies like Alpha Natural Resources and Walter Energy .

Alpha Natural Resources' high beta of 2.6 renders us skeptical given the prevailing market scenario. Recently, the company announced production cuts amounting to 16 million tons per year, and job cuts of around 9% of its workforce. The company is increasingly trying to divest away from thermal coal and increase its exposure in steelmaking coal. Therefore, it is a pure play for those investors who are targeting a rebound in metallurgical coal prices.

As mentioned above, we are more optimistic about companies with high exposures in thermal coal. In this regard, CONSOL Energy Inc. remains our favorite player, as a result of its high exposure to thermal coal (which comprised almost 63% of its most recent quarter's revenue). In addition, CONSOLs unique feature is its exposure to natural gas, which virtually shields it from coal-to-gas switching. The company is trading at comparatively expensive valuations, but we feel that it is justified, given the expected upside and limited downside potential. CONSOL is a good investment for the long term as well, considering the fact that it has a reasonable exposure in metallurgical coal also (from which it derived almost 16% of its most recent quarter's revenues).

Peabody Energy Corp is also one of our favorite coal players, as it is low on the cost curve much like CONSOL. The company's Australian coal operations did disappoint, though, according to its most recent quarter's performance, but the company is aggressively trying to reduce costs and improve productivity in that region. The company has also lowered its guidance for Q3 earnings, and has recently reduced its CAPEX range from $1-$1.2 billion to $1-$1.1 billion. The company has also been recently downgraded from "buy" to "underperform" by Bank of America, due to the high costs Peabody is experiencing in its Australian operations. However, the company's balance sheet strength, liquidity position, and cheap valuations make it one of the better coal mining players for long-term investors.

Regarding Arch Coal Inc., we stay cautious due to its high leverage to the market and comparatively weak balance sheet. The following table shows the essential components of valuation for these five mining giants.

ANR

WLT

ACI

BTU

CNX

Forward P/E (1 year)

N/A

7.95x

N/A

9.91x

17.85x

EV/EBITDA (TTM)

4.38

6.01

6.7

5.73

7.77

Dividend Yield

N/A

1.30%

1.70%

1.40%

1.60%

Share price performance (YTD)

-66.85%

-44.90%

-55.20%

-31.37%

-18.60%

Source: Yahoo Finance, Bloomberg

Source: 2 Thermal Coal Stocks To Buy, 3 Met Coal Stocks To Approach With Caution