Coal Stocks Rally! Bull vs. Bear, For Rest of Year
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Coal Stocks Up 15% in Just 3 Days, -- Now What?
The larger U.S. non-MLP coal stocks are up 15% in just 3 days, with Alpha Natural Resources, (NYSE: ANR) up 31% from its intra-day low on Wednesday. I'm getting emails from Fools and non-Fools alike asking if I think this coal market rally has legs. I definitely have an opinion, but each investor needs to consider his own time horizon, return expectations and risk tolerance. Here are a few key Bull and Bear Case arguments for the remainder of the year.
All the bad news is out: With weak 2nd quarter earnings behind us, significant industry production cuts and bottoms formed in natural gas and thermal coal prices, all the bad news is priced in. The recent collapse in spot coking coal prices to $160-$165 per metric tonne from $225 clears the decks for a more sustainable rebound next year.
China stimulus, European bond buy-backs: Last week's significant stimulus program out of China signals that the worst of the slowdown has passed and a hard landing is off the table. Europe appears to be kicking the can further down the road, with a hard landing avoided there as well.
Thermal coal prices: Prices should increase over coming months as bloated stockpiles are worked down and we get a normal winter. It's hoped that coal prices for 2013-14 will rise to levels comfortably above industry costs, thereby setting the stage for possibly strong prices in 2015.
Full year earnings estimates are too high: Analysts have largely incorporated 2nd quarter earnings into their models, but further production cuts are coming and the recent leg down in coking coal prices will decimate 3rd and 4th quarter earnings.
Natural gas prices: Prompt natural gas prices dipped below $2 per MCF earlier this year but are back to about $2.70. However, that's down considerably from about $3.10 per MCF in July. Gas prices could easily fall further in the seasonally weak Sept-Oct. period.
Spot coking coal prices are a train wreck: Spot coking coal prices are down a whopping 50% from last year's highs. Soon, 4th quarter contract settlements will be announced. Settlements are expected to be around $170-$180 per metric tonne. Analysts have reduced 2013 estimates to roughly $200 per tonne from $225-$235, but risks are to the downside.
Buy, Sell or Hold the Rally?
I'm not a buyer into this rally, but as a long-term holder I'm not a seller either. One needs to consider carefully his return expectations. I don't see another 25% up this year. I think the stocks rallied more on optimism about China and Europe then underlying coal fundamentals. For Bulls, stocks offering the best bang for the buck are Alpha and Walter Energy, (NYSE: WLT). Both have huge leverage to coking coal and the ability to export substantial tonnage.
However, be warned, Alpha is very risky with benchmark coking coal prices below $200 per tonne. Walter continues to be a prime take out candidate as a pure-play premium low-vol coking coal producer. Prospective acquirers will be looking at Walter's planned 20 million tons of coking coal production by 2020.
If Bearish, then Alpha's and Arch Coal's, (NYSE: ACI) stock rallies are unsustainable. Arch is saddled with $4.5 billion in debt after last year's ill-timed acquisition of Intl. Coal. Elevated interest expense and capital expenditures to ramp up coking coal projects will diminish the company's ability to generate free cash flow for debt reduction. I'm also cautious on Peabody Energy, (NYSE: BTU). Peabody rallied with the group despite announcing material cutbacks in Australian growth plans. The company now expects 40 million tonnes of coking coal production, down from 45-50 million tonnes. And, those tonnes will be lower margin as costs have barely budged while coking coal prices have swooned.
Coal MLP Alliance Resource Partners, LP, (NASDAQ: ARLP) looks cheap as it completely missed the recent rally, in fact it was down 2%. I believe some Alliance unit holders may have swapped into higher beta coal stocks to enjoy the ride. The relative performance of Alliance vs peers suggests that there was a lot of short covering in the go-go coal names. I really like Alliance at a price below $60 per unit, (see this article from Friday).
MockingJay2011 is long call options in ANR, CNX and WLT and long outright Vale, ARLP and NRP. 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.