4 Coal Companies Presenting Value, Should You Buy?

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Shares of coal miners have been volatile for most of the year, trading with large losses as uncertainty creates pessimism for investors. But Thursday, coal companies led the market after the EIA natural gas supply data was released. One of the reasons coal stocks had fallen lower in early 2012 is due to the prices of natural gas. Because when natural gas is higher, coal becomes a more attractive alternative for electricity. When combined with the boost in iron ore, stocks have rallied, but the question remains, is it time to buy?

Political Impact

There is a perception on Wall Street that if president Obama is re-elected it could be the end of coal companies. President Obama’s policy for clean energy is well-reported, as he continues to support the benefits of clean energy such as wind power. Romney, on the other hand, is electing to try an “every state for itself” approach, and allow individual states to dictate their own energy policy, allowing the free market to decide. This policy has been welcomed among Wall Street, as many of the jobs lost in the economy have been in energy, specifically coal, over the last several years.

A couple months ago I spoke with a financial advisor who specializes in energy in the Eastern Kentucky region of the country, JC Hensley. We discussed jobs, policy, and the importance of mining to their local economy, he said:

"In Pike County Kentucky (which is well-known for its coal mining) we have lost over 1,000 jobs in the last six months in our largest industry which is coal. It's the heart and soul of our economy."

We then went on to discuss policy and changes that he's witnessed in a small economy in relation to government control, which might relate to the slowed production of coal, in a region that is overflowing with supply:

"Policy is trying to dictate utility companies to switch over to natural gas and other means to provide energy. Neither policy or government should choose, the decision should be that of the free market."

In a nut shell, you now know why prices of coal stocks have increased Thursday, and over the last month. If natural gas rises then coal stocks will rise as well, because investors believe that higher natural gas prices will lead to increased usage of coal. Also, we might conclude that in regards to coal stocks, Romney may be the better President, as his “every man for himself’ approach will assist small economies such as those in Kentucky and West Virginia that rely on coal production for survival.

Is It Foolish to Buy?

Now that we know why coal stocks are rising, it is time to buy? We can’t debate the fact that it’s currently a challenging industry: As Alpha Natural Resources (NYSE: ANR) recently announced its plan to cut 1200 jobs and close eight mines. Arch Coal (NYSE: ACI) has also joined the job cutting party, by recently eliminating 750 jobs! Peabody Energy (NYSE: BTU) just recently cut an additional 230 jobs in addition to previous cuts. And James River Coal Company (NASDAQ: JRCC), a company with a strong presence in the Eastern Kentucky and Virginia regions has also contributed to the job cutting cause. However, despite the perception issues that arise from cutting jobs it also allows for lower costs if the market improves.

For those of you trying to determine whether or not it’s time to buy coal, just remember: Job cuts lowers expenses, Higher demand equals larger sales, lower expenses and higher sales equal improved fundamentals, and when combined with a fallen stock price it could create value/upside. The four companies I mentioned above, as being cost cutting companies, have also been the best performers on Thursday, and are still trading with large yearly losses. These are all very volatile stocks that could easily trade lower in the next week. However, almost all are priced for the worst case scenario. And although much is dependent upon the upcoming election, I do think that each of these stocks are showing the level of upside that is present in this industry. However, it would be nice for coal stocks if natural gas prices continue to rise, Mitt Romney is elected President, and demand then supports the changes that created the optimism (i.e. rising natural gas prices lead to actual higher demand of coal).

Just to be clear: This is an industry that has fundamentally worsened. These companies trade with higher debt-to-asset ratios, lower margins, and less operating cash flow. However, the fundamental loss doesn’t quite account for the excessive loss of valuation. James River, Alpha Natural, and Arch Coal have lost more than 80% of their valuation since the end of 2010. And although each company was profitable to end 2010, each has also drastically increased sales since 2010. Therefore, with the proper level of demand combined with the already, in place, cost cutting initiatives, these companies could all reach profitability to a larger degree than in 2010. I believe these are companies with large upside potential if the market improves in the slightest bit. Yet Peabody Energy is my choice as perhaps the best in this class.

Peabody has lost over half of its value despite growing sales and income since 2010. The company has strong cash flow and has weathered the storm fairly well during the last two years. However, it is still subject to market performance and perception during what could be a very volatile period during the next few months. Overall, I think investors should keep their eyes on this space during the next few months, throughout the election process. I am not certain that I would buy before the election, because with each change in the presidential race these stocks are going to move, both higher and lower. However, if Romney wins and natural gas continues to rise, then it might not be bad to pay a slightly higher premium for these stocks. And what’s even more encouraging, is even if Obama wins the election, as long as natural gas prices sustain or trade higher, then this is an industry that could still present upside. Therefore, I think next year should be a different story for this oversold space. 

BrianNichols has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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