Can These 5 Coal Stocks Survive Falling Coal Prices?

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Includes: ARCH, BTU, CLD, JRCCQ, PCXCQ
by: Stock Croc

The price of coal fell with that of natural gas in 2011. Some investors have already panicked and sold their shares, which could be a very bad decision. Below, I look at five coal stocks: Arch Coal (NYSE:ACI), Patriot Coal (PCX), Peabody Energy (NYSE:BTU), Cloud Peak Energy (NYSE:CLD), and James River Coal Company (JRCC), to see if a potential rise in the price of coal can fill the pockets of investors.

The price of coal came down during 2011 and this caused the value of coal stocks to drop. However, Arch Coal is a coal stock worth looking at because of the possibility that it is an undervalued stock. I believe that this is the case and a quick look at the valuation metrics of the stock supports my hypothesis. Yet, I would still urge investors to be wary when considering Arch Coal as a bet in the stock market. At the end of the final quarter of 2011, Arch Coal's net debt was just below $4 billion. This gives the company a debt-to-equity ratio of 1.3. If coal prices fall any further, Arch Coal could find itself in financial trouble.

Yet, I think that the stock is worth investing in because of the aforementioned metrics. For example, Arch Coal's 5-year valuation metrics are way below average. Its P/B ratio is 0.8, 33% of its 2.4 average over the past 5 years. Its P/S ration is 0.7, less than half of its 5-year average of 1.6. I believe that Arch Coal stock will be worth $16 or more by the end of the year, mainly because it has averaged growth of over 30% for each of the last 5 years. Despite a less-than-impressive year for the coal industry, Arch Coal still enjoyed a net income of almost $71 million for the fourth quarter of 2011 or $0.33 a share. With coal prices set to increase (see below), Arch Coal will rise with the tide. Currently, it is slightly over $14 a share, which is certainly undervalued in my opinion.

While Arch Coal may prove to be a solid investment, the same cannot be said for Patriot Coal. Shares in Patriot Coal have fallen in value by some 70% over the last 12 months, dipping below the $8 a share barrier. The company has closed down its Big Mountain complex and it is hoped that this will help the company keep output under control. The management of production should also help increase operating margins.

Yet, thermal coal usage is still falling in the U.S. overall. A production cut will do little to slow down the company's growing problems. A potential ray of light would be if China picks up demand from U.S. producers. This doesn't look particularly likely since China seems to be interested in coal closer to home. China Steel has just paid over $100 million to invest in an Australian coal mine in Queensland.

Like other coal stocks, Peabody Energy has had a fairly woeful last 12 months. In this time, its share price has fallen over 45%. Yet investors should not panic because Peabody Energy may increase as coal stages a recovery. The price of coal has fallen because of low natural gas prices and a relatively mild winter in 2011. However, indications are that natural gas prices will rise and raise the demand for coal prices and the equity valuation of coal stocks in turn. In the last 3 years, the supply of natural gas has increased by less than 5%, but the demand has increased by almost 10%. This alone will be enough to drive up the price of natural gas.

Currently, Peabody Energy's share price is at just over $36, but I think it has the potential to hit the $45 barrier before the end of 2012 because its Australian interests are likely to be snapped up by China and Indian steel companies. Another reason for my optimism relating to this company's stock is because its valuation metrics are way below average. Its current P/B ratio is 1.8, less than half of its 5-year average of 3.7. Its 5-year P/S ratio average is 2.3 yet it is currently at just 1.2.

One of the main reasons why Cloud Peak Energy is a coal stock worth keeping an eye on is because it is a likely takeover candidate. Cloud is one of America's largest coal producers but is currently suffering because of the poor coal market. A weakened European market has seriously reduced thermal coal exports, which are down over 20% in the last 18 months. Alternative energy sources such as natural gas have decreased in price, taking the price of coal down with it. There is the possibility that another company may try to take over Cloud, taking advantage of the low coal price to get a value for money investment. The new company would then incorporate Cloud into larger energy plans.

James River Coal is yet another organization that was damaged by the downturn in 2011. Its shares were worth over $25 at one point last year but have since plummeted to less than $7. Nonetheless, over 4 million James River Coal Company shares are traded each day, which is good news for traders looking to cut their losses, but even better for those who believe that the coal industry is due to rise.

Even if you ignore the potential increase in natural gas prices, which will help the coal industry recover, the fact that James River Coal Company acquired Logan & Kanawha Coal Company and International Resource Partners for a price that was below industry averages means that the organization has almost doubled in size. The company is also set to add a mainly non-union workforce and will gain 24 new customers in eight countries. When you combine all of these factors, I believe that they equal a very lucrative year for James River and its shareholders.

Coal seems likely to recover in 2012, but not all coal companies can be relied upon. Of the above batch, Patriot Coal could get itself into trouble if coal prices don't rise as expected. All the other companies are strong enough to withstand another downturn.

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