Are Coal Stocks Burning Hot?

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

Ever since the first U.S. Presidential debate, coal stocks have come back into focus for many energy investors who have seen these stocks up by about 30% across the board. While the rally may be partially attributed to a strong showing in the polls by Governor Romney – who declared “I like coal” – there are several global macroeconomics drivers of the rally. The recent earning beats by Peabody Energy (NYSE: BTU) and others have also helped to propel stock prices higher. The question that now must be answered is whether the rally is sustainable, likely to continue or an unsustainable burn that will likely fizzle.

A Split Decision

When Peabody released earnings on Monday, the stock screamed higher, trading up by as much as 15%. Competitors like Arch Coal (NYSE: ACI), Alpha Natural Resources (NYSE: ANR) and CONSOL Energy (NYSE: CNX) were each up significantly on the news as well. Peabody either met, beat or fell short of estimates, depending on the source you choose. The company posted earnings of $0.51 per share on revenue of $2.06 billion. Some of the concern is driven by the 84% decline in year-over-year net income, which came in at $42.9 million relative to $274.1 million a year ago.

As a result of this earnings release in part, Michael Dudas of Sterne Agee remains positive on Peabody, as well as CONSOL and Alpha Natural Resources. He sees the strength in global demand, particularly in China, as a driver of coal prices moving forward. On the other hand, Goldman Sachs analyst Andre Benjamin downgraded the stock based on his belief that the positives are all priced into the stock at current levels and he sees a lack of additional positive catalysts moving forward. Shares were off 2.4% on Tuesday following the downgrade, but have since rebounded.

Global Influences

While demand for thermal coal has declined as a result of persisting low natural gas prices, particularly in the U.S., several additional factors need to be considered. First, natural gas prices have begun to recover over the last several weeks and months; having traded below $2 / mmbtu earlier in the year, prices are back in the $3.50 / mmbtu range. Thermal coal is used by power plants to create electricity, but because natural gas may be used for the same purpose, weak gas prices tend to drive down coal prices. The recovery in natural gas is bullish for coal.

Even with strengthening demand domestically, Peabody has made clear that it is focused on global consumption in its forward-looking strategic positioning. China remains the largest consumer of coal on the planet, with Australian supply being a primary source for Chinese import. Peabody was able to increase its Australian production by nearly 40% and this should allow it to benefit moving forward.

Another significant positive for Peabody, especially relative to its peers, is the company’s ability to improve its operating margin through strong cost performance. Where Arch, ANR and CONSOL faced significant cost pressure, Peabody improved margins by 8%. Commodity production costs have been a major concern for producers ranging from gold miners to fracking operations. Peabody’s ability to buck this trend positions the company extremely well looking ahead.

Overview

As the election draws ever closer, coal investors are advised to pay attention to polling data despite the overall strength coal has shown over the last several weeks. These stocks tend to be highly volatile and the political angle is not to be overlooked; a Romney victory is considered favorable for the industry as a whole. Amongst coal stocks, Peabody continues to stand at the top of the group and is an attractive addition to your core portfolio over the long-term. On a shorter-term basis, coal stocks are subject to sufficient volatility. Thus, those seeking an entry-point should take proper care.


Mr. Ehrman 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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