Consol Energy: Low-Cost Coal Producer, De-Risked Gas Business

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Last year I wrote that Consol Energy, (NYSE:CNX) could soar if natural gas prices rebounded to $4. Clearly, natural gas did not hold up its side of the bargain. Despite persistently low gas prices, Consol has prudently de-risked its Marcellus and Utica acreage through 2 landmark joint ventures.

On the coal side, Consol is the clear the low-cost producer in the east and has one of the best low-vol coking coal mines in North America. The company has had great success marketing its high quality Northern Appalachian steam coal as an inexpensive coking coal into Asia. As a result, with both businesses on track, the traditionally steep discount ascribed to the Company's sum-of-the-parts valuation should diminish.

Most if not all U.S. coal producers have announced production cuts, and in many cases, cuts to cap-ex budgets. Patriot Coal, (PCX), Alpha, (ANR) and Arch, (ACI) were very clear that the market is weak and expected to stay weak for an extended period. Peabody (NYSE:BTU) missed the 4th quarter badly and said that 2012 is a transitional year as the company works on integrating their acquisition of Macarthur Coal. Walter, (NYSE:WLT) cut its coking coal production guidance. Cloud Peak, (NYSE:CLD) was prudent in not making acquisitions like Arch and Alpha did last year, leaving them with one of the strongest balance sheets.

Consol, on the other hand, reported a good 4th quarter. Surprisingly though, some still contend that Consol's acquisition of Dominion's Marcellus and Utica assets was a mistake. They point to the rapid fall in gas prices and complain that CNX overpaid. But, Consol has proven to be adept at managing these plays. Signing deals with respected partners Hess and Noble validated the company's strategy and assets. An interesting way of thinking about that acquisition is to recall that at the time, there was little to no mention of the Utica.

I looked back at sell-side reports from 2 years ago, Only 2 of 8 reports I searched mentioned the Utica at all! And, in the 2 reports that managed to flag the Utica acres, here's what each report said:

Stifel calculates a transaction value of $3,490 per Marcellus acre....The $3,490/acre estimate assumes$1.50/Mcfe for Dominion's proven reserves of 1.0 Tcfe, and assigns no value to Dominion's Huron Shale (300,000 acres) or Utica Shale (470,000 acres) assets.

The second note, by Raymond James:

Keep in mind that this gives no value to the 470,000 acres prospective for the Utica Shale and 300,000 acres prospective for the Huron Shale, both of which could yield additional upside and resource potential in the future.

So, that deal was valued almost entirely for entry into the Marcellus, plus some proven reserves. Common sense suggests that if Consol got the Utica for free, they did not overpay for the transaction. It's clear today that the Utica acres are worth a substantial amount. Now that CNX is a more seasoned conventional and shale gas company and the Marcellus and Utica fields are better understood by investors and analysts, it's become easier to value Consol's gas assets. With more certainty should come a lowering of the discount to NAV.

In addition to valuable and largely de-risked shale assets, I still believe that Consol's port, infrastructure, transportation and storage facilities are worth at least $3 or $4 per share. Spinning out some of these assets into an MLP structure could help monetize the value. However, I recognize that investors have been talking about an MLP for a few years now.

Consol has executed well on both the coal and the gas business, demonstrating good cost control and savvy management skills. At the risk of over-simplifying things, the only thing holding back the company is the price of natural gas. While I don't know where gas prices are headed, I do think that its fair to assume they will head higher within a few years. There's been a great deal written about the decline in gas-drilling rigs and the potential for U.S. gas to be exported once LNG infrastructure is built.

I think there's no way around the following: Gas production and the amount in storage will decline, coal-to-gas switching will put a floor under gas prices, and steep decline curves for the shale plays will curb supply. Consol is well positioned to benefit from an eventual rebound in both coal and gas prices, making it an attractive, "value" stock. While I'm not ready to buy CNX stock without signs of improvement in coal and gas prices, CNX is one of the first stocks I will pull the trigger on.

Disclosure: I am no longer invested in any of the stocks mentioned in this article. I sold all of my Jan-2013 call options in ACI, ANR, PCX, CNX, and BTU.