Is it Time to Invest in Coal?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Aside from solar, no industry in the market has been more beaten down over the last few years than coal. With that said, solar stocks saw a rebound earlier this year, and now with decent data and shifting outlooks, many believe it is now time to buy coal stocks – but is it?

What Happened?

Since January 2011, coal stocks have been the worst performers in the stock market. Take a look at the table below to see the performance of the industry leaders during this period.

<table> <thead> <tr><th> <p>Company</p> </th><th> <p>Stock Performance</p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Peabody Energy</strong> <span class="ticker" data-id="203010">(NYSE: <a href="">BTU</a>)</span></p> </td> <td> <p>(72%)</p> </td> </tr> <tr> <td> <p><strong>Alpha Natural Resources</strong> <span class="ticker" data-id="206837">(NYSE: <a href="">ANR</a>)</span></p> </td> <td> <p>(89%)</p> </td> </tr> <tr> <td> <p><strong>Arch Coal</strong> <span class="ticker" data-id="202711">(NYSE: <a href="">ACI</a>)</span></p> </td> <td> <p>(87%)</p> </td> </tr> <tr> <td> <p><strong>Walter Energy</strong> <span class="ticker" data-id="206071">(NYSE: <a href="">WLT</a>)</span></p> </td> <td> <p>(89%)</p> </td> </tr> </tbody> </table>

So, what happened to these stocks? Well, it was a collection of events, or the perfect storm as some might like to call it.

First, President Obama rolled in with his clean energy initiatives, giving incentives to use solar power. Solar is clean, while coal is not, and coupled with the falling prices of solar energy, coal began to see its demand fall.

In the process, investors thought that China could carry coal through any difficult period in the U.S., but then China’s growth slowed and they became more clean focused.

Lastly, natural gas prices tanked! In 2011, more than 90% of coal consumed by weight was used to produce electricity. Therefore, with natural gas prices falling, utility companies switched from coal to gas.

As a result, the profits and revenues of major coal companies were hurt, as were their stock prices.

What’s Going On?

After seeing the disaster that has been coal for the last two and a half years, let’s turn our attention to what’s happened in recent days. In particular, the last five days.

<table> <thead> <tr><th> <p>Company</p> </th><th> <p>Stock Performance</p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Peabody Energy</strong></p> </td> <td> <p>11%</p> </td> </tr> <tr> <td> <p><strong>Alpha Natural</strong></p> </td> <td> <p>19%</p> </td> </tr> <tr> <td> <p><strong>Arch Coal</strong></p> </td> <td> <p>18%</p> </td> </tr> <tr> <td> <p><strong>Walter Energy</strong></p> </td> <td> <p>27%</p> </td> </tr> </tbody> </table>

In the last couple months, we have seen natural gas prices begin to rise, and many believe that utility companies may elect to use coal again. In particular, Moody’s raised its coal industry outlook from negative to stable on Friday.

The ratings agency said that negative macro conditions have hit its bottom for coal, and that sustained natural gas prices will increase demand for thermal coal through early 2015. As a result, coal stocks saw massive gains last week.

Moreover, we saw strong production data from China, including reasons to believe that their steel oversupply issues may be easing. For companies such as Walter Energy, who sells both thermal and met coal – met coal is used in making steel – this data from China bodes well.

Combined, positive sentiment for both met and thermal coal, led to large gains.

Which Stocks Look Good?

If in fact coal is on the rise, or at least stable, certain companies will benefit more than others.

First off, Walter looks good, which is evident by its industry-leading gains last week. The company sells both thermal and met coal. Walter also has a notable presence in China, and the steel news could be a very important catalyst moving forward. Therefore, I’d watch Walter.

Peabody is the global coal leader. The company recently announced positive earnings, issuing in-line guidance. However, the company’s global presence might also be a reason for concern, as Australia in particular has been a problem area for the company. For example, Peabody is cutting costs in Australia by up to 20% and in the U.S. by 6%, noting high supply issues. To me, this doesn’t sound like a company on the rise.

Alpha Natural Resources announced earnings two weeks ago, and the tone was less than positive. The company talked about oversupply, margin pressure, and the market for export steam coal being “uneconomic” for most. With that said, the company’s coal shipment guidance stayed mostly in-line with its previous guidance. However, it is still hard for me to invest in a company that’s not optimistic about its own future.

Lastly, Arch Coal, which is very similar to Alpha Natural Resources. Both have large supplies of met coal, have negative cash flow, but do have liquidity cushions for now. Hopefully, the recent steel news in China will bode well for Arch Coal. Also, the company was one of the first to mention that stockpiles in the U.S. for thermal coal were improving. Combined, these factors could be positive moving forward, but like I said, Arch faces the same concerns as Alpha Natural Resources.

Final Thoughts

Peabody will be attractive to many because of its 2% yield, but its massive presence in an industry that is still very vulnerable is concerning to me.

Alpha Natural Resources and Arch Coal could be good investments, but neither seem too optimistic about their own outlooks.

Therefore, I think Walter is the clear winner in this particular space. It has the most to gain from Chinese steel demand, and also in the U.S. if more coal is used for electricity. With that said, this is still a highly volatile space, and I urge caution and proper due diligence before making any investments. However, as an investor who looks at the glass half full, I think the current upside is greater than the current downside, and I am taking a small chance on Walter. 

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