Is It Finally Time To Look At Coal?

By: Wayne Duggan

Oil has captured the lion’s share of the headlines surrounding the collapse in commodity prices over the past year, but many coal mining stocks have been hit even harder than oil stocks have.

With share prices at historical lows, is it finally time to buy coal or will coal stocks remain value traps for years to come?

Weakening Demand

At the moment, both the coal industry and the oil industry are suffering from weakening global demand, particularly in China. This week, China reported a 17.7% month-over-month decline in its August coal imports, a number that sent share prices of coal producers such as Arch Coal Inc (NYSE: ACI) plummeting.

The “War on Coal”

Although coal and oil stocks have declined mostly in tandem lately, there is a much stronger sense on Wall Street that the down-cycle in the coal industry could be more permanent.

Whether it’s right or wrong, the coal industry has become the poster child for the antiquated, environmentally harmful 20th century energy business. Perhaps more importantly, it has become the scapegoat for many politicians when creating new environmentally-friendly clean energy regulations.

Moody’s projects that new EPA regulations could cut U.S. coal demand 20% by 2020. California recently became the first state to ban pension funds from owning coal-related stocks. Similar bills will likely soon be on the table in New York and Massachusetts.

The Bad News

For the majority of the Energy sector, a slowdown in China’s economy and even a global recession might put a damper on energy demand in the short-term, but long-term global energy demand will continue to rise indefinitely.

global-energy

Unfortunately, coal’s share of global energy demand is headed in the wrong direction. According to the U.S. Energy Information Administration (EIA), coal’s percentage of U.S. energy generation has consistently fallen from 48.5% in 2007 to only 38.7% in 2014, and the EIA projects that percentage will continue falling to 35.8% by 2016.

us-electricity-generation

The Good News

Despite the possibility of a secular decline in coal’s share of global energy production, demand for coal continues creeping higher. Recent BP projections show global coal demand growth continuing through 2035, although at a much slower pace than it has grown in recent decades.

global-coal-consumption

The EIA projects that much of this growth will come from India’s steadily increasing demand over the next 25 years. Coal bulls will be heavily relying on India to pick up on China’s slacking demand if recent weakness in China persists.

india-coal-consumption

Valuation

Alpha Natural Resources Inc (NYSE: ANR) is the latest (and biggest) coal company to wave the white flag of bankruptcy, joining Patriot Coal, Walter Energy Inc, and James River Coal.

However, the coal stocks that are left standing are currently trading at historically miniscule valuations. In fact, Consol Energy (NYSE: CNX) (0.65 P/B), Peabody Energy Corp (NYSE: BTU) (0.33 P/B), Cloud Peak Energy Inc (NYSE: CLD) (0.20 P/B) and Arch Coal (0.07 P/B) are all currently trading at major discounts to book value.

Top Pick

Despite the market weakness, Consol remained profitable as recently as Q1 before reporting a $603 million loss in Q2.

In August, Cowen reiterated its Outperform rating on Consol and set a $20 price target for the stock. According to the fund’s most recent 13F filing David Einhorn’s $8 billion Greenlight Capital fund has Consol as its fourth largest holding. Einhorn specifically likes the company’s positioning as a low-cost supplier.

The timing of a bounce-back in coal remains up in the air, and both China’s economic stability and the prevalence of anti-coal legislation will continue to be unpredictable. However, one thing remains certain: demand for coal is not going away any time soon.

Of the group, Consol potentially seems to be the best buy for traders looking to bet on a coal recovery.

Disclosure: the author holds no positions in any of the stocks mentioned.

Lime Brokerage LLC is not affiliated with these service providers. Data, information, and material (“content”) is provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities. Any investment decisions made by the user through the use of such content is solely based on the users independent analysis taking into consideration your financial circumstances, investment objectives, and risk tolerance. Lime Brokerage LLC does not endorse, offer or recommend any of the services provided by any of the above service providers and any service used to execute any trading strategies are solely based on the independent analysis of the user.

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