Changes In The Coal Landscape

by: Seth Walters

Coal investors and traders may be familiar with my previous article covering the coal space, wherein I advocated some American coal companies as value traps and some as value plays. In this article, I will update how my recommendations have worked out, and share with you my insights obtained by continued monitoring of the market.

Here is how the stocks I discussed in the first article have performed so far:

And here is my analysis of their performance, and some thoughts about their future in light of the upcoming U.S. presidential election.

Walter Energy (NYSE:WLT) - Walter Energy is a nearly pure metallurgical coal play, and as such is levered to demand for met coal. Although it remains a profitable company, the outlook for met coal in 2013 is about identical to what we saw in 2012. The world steel industry does not seem to be in danger of collapse, but is not terribly healthy now either at the moment. Furthermore, new supply sources of met coal are starting to come online, and this may limit a big rebound. If Romney is elected and WLT rallies, sell it - the rally will be undeserved. The EPA has a much smaller effect on WLT than the other companies on this list. Conversely, if Obama wins and WLT plunges, buy it on the plunge, as there is no reason for it to fall and it should right itself quickly. I am less bullish on Walter now than I was in September, but if China's new Party Congress launches new stimulus in November, WLT will go back to being a strong value play.

James River Coal Company (JRCC) - To the best of my knowledge, James River's situation has not changed since I last wrote. With Intrade putting Romney's election chances at 1 in 3, I would give JRCC the same odds of long-term survival. An Obama victory will undoubtedly crush JRCC - both the stock and the company. The +87% speculative rally it has undergone since I last wrote is largely because of natural gas, but even $3.60/ mmBTU sustained natural gas won't help JRCC survive, as closer to $4.50/mmBTU is needed for CAPP coal in general, and JRCC is at the high point of the cost curve. If Romney gets elected and natural gas can make its way up to $4.50, JRCC will undoubtedly rally powerfully. However, the company still has not made an overall net income since 2004, even counting the years when the EPA was friendlier and natural gas was sky high and no threat to coal. I therefore must continue to caution against JRCC as an investment. However, as we have seen, JRCC may be a good *trade* to play a Romney victory. Tread very carefully here; there is a reason for the outsized gains JRCC has seen recently, and it is not a very bullish one for the long-term investor in my opinion.

Alpha Natural Resources (ANR) - remains a play on natural gas going back above $4.50/mmBTU. Obama or Romney, ANR is not in good shape if gas cannot sustain these price levels. With the met coal outlook much less than stellar, this can't be expected to support the company either. However, ANR may perform very well if gas does trade high again, OR if China launches new stimulus. While I am not counting it out just yet, I don't currently feel comfortable with the idea that ANR is a good investment. Of course, circumstances can change, and when they do will be the time to pounce. Currently neutral on ANR.

Consol Energy (NYSE:CNX) and Alliance Resource Partners (NASDAQ:ARLP) have had weak gains, but they are stable investments at the low end of their basins' cost curves, and they have had gains. These are actually great coal stocks to be in if the price of natural gas plummeted again for a while (although I'd try to get in closer to the bottom in the unlikely and unforeseen event that that happened, because they get to eat some of the market share of the higher cost producers that go belly-up if that happens).

Peabody Energy (NYSE:BTU) continues to be the cream of the crop. My views have not changed from my earlier article on it. There are a lot of somewhat disquieting headwinds starting to pile up against the company though, from lawsuits over Patriot to China starting to push more towards nuclear energy. I have confidence the company will be able to navigate any hurdle that is thrown at it in the long term, based on past shrewd decisions and the strong track record I pointed to in the previous article. But, the company is starting to become fully valued in forward P/E, and the coming election will undoubtedly see the stock go strongly one way or the other. A 2/3 Obama reelection chance does not speak well for the stock price evolution in the near term, and so I think it is very likely that stouthearted long-term coal investors will have an excellent buying opportunity in two weeks, which is part of why I decided to exit my position recently.

Arch Coal (ACI) is a lot like Peabody, except with less demonstrated strategic foresight, and assets in Appalachia instead of Australia. They were actually profitable this quarter, which is a major plus. I continue to believe they will outperform the market, but watch out for ACI to become a falling knife for a while on November 6th.

Cloud Peak Energy (NYSE:CLD) is a company I was probably too bearish on in my first article. I am now starting to think they will do OK from here on out, but I wouldn't expect any better long-term performance from it than CNX or ARLP, which pay dividends.

So, to sum things up, the coal plays I considered good values have all made money even in a falling S&P500 (1429 when I wrote the article to 1412 today). BTU and ACI are still up about 20% each. I have adjusted my opinion somewhat on a few of them based on further evolution of macro factors like met coal and rising natural gas prices, and readers are on notice that there are tipping points that can change the risk/reward profile of several of these equities. I believe that an Obama re-election is the most likely outcome come November, and between that and the current overall macro environment, I don't think it makes a lot of sense to be in coal names now. Even if you are strictly a long-term investor, avoiding the big drops ought to be helpful. Of course if Romney wins, I fully expect the most levered names to take off big time - but I'd wait until after the election to be in the coal names either way - especially considering the overall market tenor at the moment.

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.