Tough Short Term Will Give Way For Coal To Rebound In Long Term

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Includes: ANRZQ, ARCH, BTU, KOL, WLT
by: Equity Watch

Summary

Coal market conditions have been negatively affected by environmental regulations, global economic slowdown and lower gas prices.

Negative impacts will continue to weigh on stock prices of leading U.S. coal companies in near term.

Production cuts, expected increase in gas prices and strengthening of Chinese coal imports will portend well for coal markets in long term.

Coal will remain an important global energy portfolio component in future.

In recent times, global coal demand has been negatively affected by weak global economic conditions, lower gas prices and strict environmental regulations. Weak coal market conditions have taken a toll on the stock prices of leading U.S. coal companies like Peabody Energy (NYSE:BTU), Alpha Natural Resources (ANR), Arch Coal (NYSE:ACI) and Walter Energy (NYSE:WLT). Despite the ongoing challenges, I believe coal demand will rebound in the long run and coal will remain a key component of the global energy portfolio. Also, due to the wide availability and lower cost, coal will remain an important energy portfolio component. Moreover, an expected rise in natural gas prices will increase the coal share in electricity generation. Also, improved economic conditions, especially in Asia, will support met coal prices in the long term. Furthermore, according to the recent quarterly coal report by the Energy Information Administration (EIA), U.S. coal producers are cutting their production to support prices. However, in the near term, ongoing challenges in the coal market will continue to adversely affect stock prices of leading U.S. coal companies.

Thermal and Met Coal Markets

The thermal coal market has been negatively affected by environmental regulations, rail issues and lower gas prices. Due to strict environmental regulations, coal power plants with a generational capacity of 20-25GW are expected to retire in 2015. However, despite the coal plant retirements, the coal share in electricity generation is expected to remain in a range of 37%-to-39% in 2015 and 2016, which will support thermal coal demand. The following chart shows that coal will continue to hold a significant share in U.S. electricity generation in 2015 and 2016.

Source: eia.gov

Also, the recent drop in gas prices has discouraged coal-electricity generation, which has weighed on thermal coal demand. However, according to the EIA, natural gas prices are expected to rise from the current level of $2.7 mmBtu to $3.7 mmBtu by the end of 2016, which will make coal-fired electricity generation more cost competitive and result in higher coal-fired electricity generation, which will portend well for the thermal coal market.

On the other side, weak emerging market conditions and excess coal supply have taken a toll on met coal demand and prices. Chinese met coal imports for 2014 were down more than 15% year-on-year. Also, approximately 30 million tons of met coal supply cuts have been announced since 2014. However, as coal mines take time to shut down, the announced supply cuts will be realized by the end of 2015; until the end of 2015, excess supply will prevail and met coal prices will remain weak. Along with supply cuts, the strengthening of Chinese met coal imports will portend well for met coal market fundamentals. Chinese met coal imports have started to show signs of improvements, as its met coal imports for February increased to 3.96 million tons, up 12% year-on-year. However, given the prevailing excess met coal supply, the met coal market will remain weak and prices will remain soft until the end of 2015.

According to the quarterly coal report published by the EIA last month, U.S. coal production dropped to 255.3 million tons for 3Q'14, down approximately 1% year-on-year.

Source: eia.gov

Look Into Coal Stocks

As coal market conditions remain weak, U.S. coal companies are correctly making efforts to reduce their operational expenses. The cost reduction efforts will support earnings of the companies in the ongoing difficult times and support the stock price of coal companies in the long term. The following chart shows that due to cost reduction efforts, BTU, ANR and ACI reported positive earnings surprises for 4Q'14.

BTU

ANR

ACI

Actual EPS ($)

0.05

-0.51

-0.37

EPS Estimates ($)

-0.34

-0.7

-0.38

Earnings Surprise

110%

30%

2.6%

Source: Yahoo Finance

As coal production cuts will be realized in the coming quarters, along with the expected increase in natural gas prices and strengthening of Chinese coal imports, I believe the U.S. Coal Industry will benefit in the long term. Also, analysts are also expecting earnings per share of four U.S. coal companies to improve in the coming years, which strengthens my thesis that coal companies' performances will improve in the long term. The following table shows the improving EPS of U.S. coal companies from 2015-2018.

2015

2016

2017

2018

BTU

$(1.07)

$(0.35)

$(0.27)

$0.16

WLT

$(5.76)

$(3.87)

$(2.97)

-

ANR

$(2.78)

$(2.34)

$(2.28)

$(1.6)

ACI

$(1.92)

$(1.47)

$(1.26)

$(0.70)

Source: nasdaq.com

Conclusion

Coal market conditions have been negatively affected by environmental regulations, global economic slowdown and lower gas prices, which will continue to weigh on the stock prices of leading U.S. coal companies in the near term. However, I expect production cuts, the expected increase in gas prices and the strengthening of Chinese coal imports to portend well for coal markets in the long term. And the stock prices of BTU, WLT, ANR and ACI have bottomed out. Also, despite ongoing challenges, coal will remain an important global energy portfolio component in future. Therefore, I expect coal market to rebound in the long term, and believe coal stocks remain a good investment option for long-term investors.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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