Why Coal Stocks Might Bottom Out Around November And Bounce Into January

Includes: ANRZQ, ARCH, BTU
by: Trade In Mexico

Coal has been one of the worst-performing sectors in the market in 2012. Due to the plunge in many coal stocks, some investors have tried to go bargain hunting. However, there are a couple of reasons why these stocks could still be too risky to own, as downside potential remains. A recent Barron's article states that some analysts still can't see the bottom for this sector. However, there is a good chance these stocks might bottom out sometime in November due to tax loss selling, and a potential Presidential election victory by Obama. Then the stocks could rally, purely on a shift in supply and demand balance. The stocks could rally into January as the supply of shares being sold for tax loss purposes ends. First let's look at what caused this sector to plunge:

The price of coal has been weighed down by excessive inventory levels, and a major slowdown in the Chinese economy. Since China is the world's biggest importer of coal, coal prices are very sensitive to the perceived state of that economy. Combine that with recent fears that the United States might fall back into recession, especially with the fiscal cliff looming, it's easy to see why prices are falling. Another reason for weakness in coal has been due to the low price of natural gas. Many utilities are switching from coal to natural gas, since it is so cheap. This trend could continue, unless natural gas prices rise in the future.

Based on the current industry dynamics, plus the fact that underperforming stocks tend to see heavy tax-loss selling pressure in the fourth quarter, it's unlikely that the sector is poised to rally. In fact it could drop further, especially if President Obama wins a second term. Many investors believe that the Obama Administration is "unfriendly" towards the coal industry due to increased regulations and new laws that make it difficult, if not impossible for new coal plants to be built. One CNBC article quotes House of Representative Republican Shelley Moore Capito, (of West Virginia) as stating: "Obama has said if you build a new coal plant we're going to bankrupt you." A second term could lead to even tighter regulations from the Obama Administration, so if he wins, it's not hard to imagine another sell-off in the sector.

However, many coal stocks have been and remain shorted. That means there could be a buying opportunity in what might be a final capitulation sell-off in this sector, later this year. Investors who patiently wait on the sidelines and buy when tax-loss selling could be peaking in late November and December, (and after the election), could be poised to gain from a rebound into January. That is because these stocks could benefit once significant tax-loss selling ends on December 31, 2012. That should create some strength in these stocks, which might also see short covering at that time as well. Here are some coal stocks that are likely to see tax-loss selling pressure in the next couple of months, and possibly another sharp sell-off if Obama is re-elected. However, that could be the bottom (at least in the short term), and a buying opportunity as these stocks could see a relief and short-covering rally into January:

Arch Coal, Inc. (ACI) is a major coal producer with annual revenue of about $4.5 billion. It also has a major debt load with a balance sheet that includes about $4.58 billion in debt and around $512 million in cash. The decline in the price of coal makes the debt an even bigger concern. This stock has not performed well in the past year, and that is why it could see heavy tax-loss selling pressure in the coming quarter. For example, the shares are trading for a fraction of the 52-week high, which is $20.37. Analysts at BMO Capital Markets recently downgraded the shares and set a $4 price target, due to concerns over profit margins and the balance sheet. Furthermore, analysts expect the company to post losses in 2012 and 2013.

Key Data Points For Arch Coal From Yahoo Finance:
Current Share Price: $6.43
52-Week Range: $5.16 to $20.37
Dividend: 12 cents per share, which yields 1.7%
2012 Earnings Estimate: a loss of 44 cents per share
2013 Earnings Estimate: a loss of 46 cents per share
P/E Ratio: n/a due to losses

Alpha Natural Resources (ANR) is one of the largest coal companies and it has annual revenue of about $8 billion. It also has a balance sheet that concerns some investors with about $3 billion in debt and just around $353 million in cash. This stock was also recently downgraded by analysts at BMO Capital with a $5 price target. This stock is trading for about a quarter of the 52-week high, so it's likely that many investors have losses that they might want to harvest for tax purposes at the end of this year. Analysts expect this company to post losses this year and next year, so it looks too early to expect a turnaround.

Key Data Points For Alpha Natural Resources From Yahoo Finance:
Current Share Price: $6.69
52-Week Range: $5.28 to $29.29
Dividend: none
2012 Earnings Estimate: $1.45 per share
2013 Earnings Estimate: $1.55 per share
P/E Ratio: n/a due to losses

Peabody Energy Corporation (NYSE:BTU) shares were recently downgraded by analysts at Brean Murray due to "valuation, weak market conditions, reduced met coal forecasts, and lack of catalysts." This company has about $8.29 billion in annual revenue. The balance sheet shows about $489 million in cash and around $6.39 billion in debt. However, even though the debt level is significant, it might not be as worrisome for Peabody since analysts expect this company to remain profitable. Still, these shares are trading for about half of the 52-week high, and that means the stock could be hit by tax-loss selling. It also is likely to be impacted by the outcome of the Presidential election, but that could be a buying opportunity as the stock could be poised to rally into January once tax-loss selling fades.

Key Data Points For Peabody Energy From Yahoo Finance:
Current Share Price: $22.91
52-Week Range: $18.78 to $47.81
Dividend: 34 cents per share, which yields 1.4%
2012 Earnings Estimate: $1.97 per share
2013 Earnings Estimate: $2.33 per share
P/E Ratio: about 12 times earnings

Data sourced from Yahoo Finance. No guarantees or representations are made.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Please consult a financial advisor before making investments.