Coal Companies' Prospects Much Weaker Than 2 Years Ago
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Coal Stocks Decimated Since Early 2011
A quick glance at the percentage change from 52-week highs for stocks like Alpha Natural Resources, (NYSE: ANR), Arch Coal, (NYSE: ACI), Walter Energy, (NYSE: WLT) and Peabody Energy, (NYSE: BTU) masks even greater damage inflicted on the group. These four stocks are down about 32% to 58% from 52-week highs, but down 63% to 85% from early 2011. Alpha and Arch are down the most, 85% and 80%, respectively.
This kind of stock carnage typically attracts bottom fishers and value investors. But Foolish investors should be reminded that there has been a sea change in the coal industry. In a piece I wrote [see here] on December 4 I looked at the unbelievable change in Earnings Before Interest, Taxes, Depreciation & Amortization, "EBITDA" expectations for the year 2013, quote,
"...I find it useful to look at consensus earnings estimates from 1 year ago in assessing the attractiveness of the coal stocks today. For example, Peabody Energy's consensus EBITDA estimate for 2013, (i.e. what the 2013 consensus was a year ago) was $3.1 billion. Today, the 2013 consensus is 41% lower at $1.8 billion. Back then, analysts expected Peabody's 2012 EBITDA to be 31% above 2011's very strong showing."
Since early December, Peabody's consensus EBITDA for 2013 has dropped to $1.6 billion. In fact, looking only at analyst updates from the past month, the average is $1.5 billion. Peabody is trading at an Enterprise Value, "EV", [Market Cap + debt - cash] to 2013 expected EBITDA ratio of 8x, (or 8.5x if one uses the $1.5 billion figure). This is simply not a cheap stock. Alpha and Arch are trading at even richer valuation ratios of, 9.8x and 8.9x, respectively.
Even if one argues that these high ratios are on bottom of the cycle earnings, it doesn't matter unless future forward multiples will be as strong, (7x-8x) as they were back in 2010-11. That's an aggressive assumption to make at this stage. Two years ago, coking coal prices were above $300 per metric tonne, a price at which coal companies can mint money. Today the most investors can prudently hope for is $225 per tonne next year. At that level coal producers can do well, but are not worth a premium multiple.
What does 2013 have to offer? Rich valuations, elevated debt levels and margins that are a third to a half lower than that of 2011. Investors buying these stocks hoping for an earnings rebound in 2013 will be disappointed. Looking at Alpha, it has $3 billion in debt vs. consensus 2013 EBITDA of about $500 million, for a debt to EBITDA ratio of 6x. This debt leverage is a real burden on the company. For example, Alpha had to issue 9.75% coupon debt at a discount to maintain adequate liquidity through 2014.
What Will it Take For Coal Stocks to be Cheap Again?
Investors should give up on 2013 and focus on 2014. However, in my opinion visibility is still quite poor beyond 1h 2013. What is fairly clear is that the outlook for 1h 2013 remains dismal. Quarterly coking coal prices have been set for 1q 2013, and they aren't pretty. At $165 per tonne, coking coal is down exactly 50% from the June, 2011 quarter. With lower industry volumes, unit costs remain stubbornly high.
Instead of an EV / 2013 expected EBITDA ratio of 8x-10x, I want to see ratios of 5x-6x of 2014 before I get excited. How reasonable is that? Alliance Resource Partners, (NASDAQ: ARLP) is trading at just a 4.5x multiple of expected 2014 EBITDA. And, select gold, copper and E&P companies are trading in the 4x-6x range as well.
Don't be Fooled by Low Stock Prices
As mentioned earlier, the coal stocks have gotten crushed from 2011 highs. However, that alone is not a good reason to buy. With coking coal prices well below $200 per tonne, stockpiles at Utilities still way too high, natural gas prices too low and a warm winter thus far, the coal stocks are at best fair value. Said another way, these stocks could be value traps. I am waiting for a pullback in the coal producers before diving back in. For example, Alpha below $8 per share, Walter in the low $30's. If a pullback does not occur, then investors should look elsewhere for solid returns in 2013.
MockingJay2011 owns shares of Alliance Resource Partners, L.P. and Walter Industries. The Motley Fool recommends 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!