The Return Of King Coal And The Stocks To Play The Rebound

Tougher regulations from the Environmental Protection Agency (EPA), the shale gas revolution and economic slowdowns in key global economies led to a decline in coal prices and share prices of publicly traded companies. However, I believe coal will remain an important component of energy portfolios, therefore, coal markets will rebound in the medium-to-long term and the weakness in the share prices of publicly traded companies presents a good investment opportunity for investors. Coal stocks are likely to benefit from the recently increasing natural gas prices, expected increase in coal-fire electricity generation and an improvement in economic activities in key economies around the world.

The following table shows the market capitalization lost by major U.S. coal companies since the second quarter of 2011.

	Peabody Energy (BTU)	Alpha Natural Resources (ANR)	Arch Coal (ACI)	Walter Energy (WLT)	Coal ETF (KOL)
Market Cap. Lost Since 2Q2011	-76%	-92%	-88%	-92%	-64%

Source: Google Finance

The shale gas revolution resulted in lower natural gas prices, which prompted more natural gas usage for electricity generations; in April 2012, natural gas prices dropped to approximately $1.95 mmBtu. Higher natural gas consumption resulted in a coal consumption drop, which led to excess coal supply and weak coal prices. However, lately natural gas prices has shown some strength and the EIA expects natural gas prices will regain/maintain strength in the ongoing year, 2014; currently, natural gas prices are at $4.65 mmBtu and the EIA expects natural gas prices to stay above $4 mmBtu in 2015 and 2016. The increase in natural gas prices will portend well for the coal industry, as rise in gas prices will result in higher coal-fired electricity generation. Coal-fired electricity generation is expected to increase to 40.3% in 2014, up from 39% in 2013 due to rising natural gas prices. The following chart shows the expected natural gas prices and U.S. electricity generation by fuel types.



Source: eia.gov

Another important driver for the coal industry remains addressing the issue of excess coal supply. Some coal companies are curtailing their coal supply, but I believe production cuts need to be observed at the industry level. Recently, ANR announced to lower its net coal production guidance by 2 million tons to 16-18 million tons. As more production cuts will be observed in the industry, it will improve demand and supply fundamentals, which will lead to a recovery in coal prices. The improvement in economic conditions of key economies also remains important, as it will benefit U.S. coal exports. U.S. coal exports are important for a rebound in the coal industry, as coal exports in recent years have stayed at healthy levels. The following table shows U.S. coal production, consumption and exports. (2014 stats are based on expectation. And all data is in million tons).

	2010	2011	2012	2013	2014*
Total Coal Production	1,084	1,095	1,016	995	1,034
Total Coal Production	1,048	1,000	890	920	958
Total Exports	81	107	125	117	106

Source: eia.gov

A look Into Coal Stocks

Coal companies are working hard to survive through the industry downturn. The efforts the companies are making include improving cost structures to support bottom line results and cutting capital expenditure to preserve cash. For the recent fourth quarter, BTU, ANR, WLT and Alliance Resource Partners LP (ARLP) registered an earnings beat. The primary reason for better-than-expected earnings for the recent fourth quarter was the aggressive cost cutting efforts undertaken by the companies. The following table shows actual and estimated earnings for the companies.

	BTU	ANR	WLT	ARLP
4Q2013 Actual EPS ($)	0.0	-0.52	-0.55	1.85
4Q2013 Estimated EPS ($)	-0.1	-0.62	-0.84	1.56
Earnings Surprise	100%	16%	35%	18.5%

Source: Yahoo Finance

My thesis that coal stocks will rebound in the future is also supported by analysts' EPS forecasts for coal companies. The following table shows analysts' EPS forecast for BTU, ANR, ACI and WLT from 2014-2017.

	BTU	ANR	ACI	WLT
2014	$0.05	($2.1)	($1.43)	($3.13)
2015	$0.86	($1.37)	($0.84)	($1.13)
2016	$1.58	($0.97)	($0.69)	($1.1)
2017	$1.93	($0.45)	$0.26	($0.99)

Source: Nasdaq.com

Conclusion

Coal markets are expected to improve in the future due to rising natural gas prices, higher coal-fired electricity generation and rationalization of coal supply and demand. BTU is my stock pick to play the coal market rebound. BTU has a competitive edge, as the company has geographically diverse operations; has operations in the U.S. and Australia. Also, the company has a lower forward P/E of 8.8x, in contrast to ACI's forward P/E of 16x (forward P/E's are based on 2017 EPS estimates). Moreover, BTU has a higher gross margin of 19% and lower debt-to-equity of 150% as compared to its competitors' average, as shown below in the table.

	BTU	ANR	ACI	WLT	Average
Forward P/E (based on 2017 EPS est.)	8.8x	-	16x	-	-
Debt to Equity	150%	84%	230%	370%	210%
Gross Margin	19%	16%	12%	16%	15.5%

Source: Yahoo Finance and Calculations

Below are the links to my recent articles on individual companies:

- Peabody Energy Corporation

- Alpha Natural Resources, Inc.

- Arch Coal, Inc.

- Walter Energy, Inc.

Source: The Return Of King Coal And The Stocks To Play The Rebound

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. (More...)

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