Not All Coal Companies Are Created Equal
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sometimes the reason to sell a stock has less to do with the value you see in your current holding and more to do with the potential value in an alternative investment. This was the case when I recently made the choice to replace Peabody Energy (NYSE: BTU) with Alliance Resource Partners (NASDAQ: ARLP) in my own portfolio.
I've written before on multiple occasions about the potential value that I see in Peabody. The company is the world's largest private-sector coal company, and while some would argue that natural gas will replace coal as the most popular fossil fuel, the numbers don't appear to bear this out. With this as the backdrop, I wanted to keep some exposure to the coal industry, but I simply found Alliance Resource to offer a better value.
With Peabody Energy reporting earnings, investors got a look at what's been going on in the coal industry. Along with natural gas competition, the industry is also being affected by the same currency fluctuations that have hurt earnings at many multinational corporations. If there's any question about coal's continued popularity, consider these few facts. First, according to Peabody, “coal now accounts for 30.3% of global energy consumption, the highest since 1969.” Second, China's net coal imports have increased 74% year to date, India's coal fueled generation is up 11%, and even European coal generation is up 12% year to date. This clearly shows significant demand for the fuel, and because natural gas prices have recently risen, coal stockpiles have declined 35% more in June than normal. All of these factors lead me to believe that the coal industry will be around for a long time. Given this assumption, it becomes a question of which companies will benefit investors the most?
Peabody Energy operates two primary divisions, one in the United States and one in Australia. The U.S. division showed revenue up 4.3% with shipments down slightly. However, because of Peabody management's cost containment efforts, EBITDA increased 27%. In the Australian market, revenues increased 3.2%, on a 26% increase in volumes. The reason revenues were not up more significantly was the company saw a 19% decrease in coal pricing. The company worked through recent acquisitions and battled pricing pressures, causing EBITDA to drop over 39%. In my eyes, there's no question that Peabody has the opportunity to adjust its cost structure in its Australian division to improve results going forward. This is a commodity business where I honestly believe the most efficient operator wins.
One way for investors to determine the most efficient operator is to look at the company's operating margin. Since I previously held Peabody shares, this was one of my first steps in trying to determine if I should continue with this holding or move my investment dollars elsewhere. Some of the companies I considered were Arch Coal (NYSE: ACI), Alpha Natural Resources (NYSE: ANR), and the previously mentioned Alliance Resource Partners. Where Arch Coal and Alpha Natural Resources are concerned, both companies are suffering from the decrease in coal demand and their operating margins show a huge challenge going forward. Alpha Natural Resources pays no dividend yield, is only expected to grow 5% for the next few years, and the company's operating margin has recently run into the negative. This immediately eliminates this company from contention. Arch Coal is in a slightly better situation, since they do pay a dividend with a current yield of 1.56%, and their operating margin is at least positive at 5.2%. However, the stigma of having recently cut their dividend will likely cap shareholder gains until the overall coal market turns around. This leads us to our final two contenders.
For investors looking for a pure play on coal generation, Peabody Energy still represents a good value. The company's yield of 1.63% isn't tremendous, but unlike Arch Coal and Alpha Natural Resources, the company is expected to report positive earnings. With a forward P/E ratio of about 10, and 8.6% growth expected, when the market turns around Peabody should benefit directly. In the meantime, the company's operating margin of nearly 14% easily trumps many of their competitors and should allow the company some wiggle room.
When it comes right down to it, the reason I chose Alliance Resource Partners to replace Peabody had a lot to do with the company's much better yield and higher margins. At current prices, Alliance Resource pays a yield of better than 6.7%, is expected to grow at about 7%, and their operating margin is higher at 20.7%. Given the choice between one company (Peabody) paying a 1.6% yield with 8.6% growth, and a company paying a 6.7% yield (Alliance) with 7% growth, this choice is a no-brainer. The fact that Alliance also sells for a forward P/E ratio of just 8.87 was just another positive factor to favor this company.
As I said before, sometimes it's not a question of the value behind a company you own, it's just that there are better values elsewhere. In this case, Alliance Resource Partners seems to represent the best value in the coal industry.
MHenage owns shares of Alliance Resource Partners, L.P. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Alliance Resource Partners, L.P.. 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.