A Coal Stock That Offers Plenty of Upside

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

Most coal companies are struggling with their profitability due to the constrained industrial demand and weak macroeconomic conditions. But despite macroeconomic headwinds, shares of CONSOL Energy (NYSE: CNX) have risen by nearly 20% over the last year. Although investing in the mining industry is not advisable at the moment, CONSOL Energy being an exception, seems to offer a significant upside.

Growth Prospects

CONSOL Energy is one of the largest coal producers in the U.S and generated around 74% of its total revenues from coal in Q1FY12. But the company is gradually shifting its focus towards natural gas production, which has been the reason behind its impressive financial performance. This has being done by ramping up natural gas production, instead of cutting down coal production. Naturally this move not only boosts its revenues, but also adds diversity and stability to its top line.

In order to do that, CONSOL Energy expanded its presence in the Marcellus region last year, after which it became the largest driller in the region. This was followed by a 60% surge in its Q1FY13 natural gas production, which, coupled with rising gas prices, resulted in blockbuster results. Additionally, its management is expecting margin expansion in its natural gas segment due to “declining unit production costs and higher realizations.”

Even its coal segment is doing well. Due to the relatively colder winter, coal stockpiles declined last year, which meant that this year coal companies began restocking their supplies. During the earnings call, the management of CONSOL Energy said that it had 2 million tonnes of met coal stockpiles, out of which around 1 million tonnes was yet to be priced. Since production costs have already been incurred in Q1, these accounts receivable would only contribute to a better Q2.

Besides that, it’s also worth noting that producing natural gas acts as a natural hedge for coal production. If natural gas continues to replace coal, CONSOL Energy would benefit from rising natural gas volumes. As of April 13, the company had hedged out around 46% of its entire natural gas production at an average price of $4.69 / Mcf. This further reduces the market risks of volatile natural gas pricing, and limits the gains to its rising volumes.

Peer Talk

But not all coal producers are having a great time. BHP Billiton (NYSE: BHP) has been dragged down by its towering net debt of over $30 billion. Its long term debt of $28.33 billion has more than doubled over the last year. And to meet its debt maturities along with rising interest expenses, the company will be divesting 10 of its non core assets.

Besides that, BHP Billiton also sold two of its Australian coal mines due to a weak coal outlook. Its management recently announced that it has scrapped all its coal projects for FY13, and would also be looking to sell one of its coal mines in the U.S. But the company has come forth with a $1.9 billion annual cost saving plan, which altogether bolsters BHP’s turnaround story.

Even Peabody (NYSE: BTU) has a rather higher debt/equity ratio of 126% compared to BHP Billiton’s 113%. Its long term debt aggregates to $6.14 billion, which has risen by almost 90% over the last 5 years. But Peabody posted a net loss of $672 million last year, which offers little hope for its debt reduction. With that in mind, I don’t think its growth prospects are compelling enough to outweigh the cons.

However, CONSOL Energy operates with a relatively lower debt/equity ratio of 81%. Its long term debt stands at $3.13 billion, while its short term debt comes to just $39 million. The company also has around $2.4 billion in liquid positions.

Final words

In my opinion, CONSOL Energy sports a healthy balance sheet and gives little reason to worry about its long term debt. The company also has ample growth prospects, which reduces its operational risks. Hence its not hard to justify why BMO Capital Markets has and outperform rating for CONSOL Energy with a price target of $40 per share (around a 26% premium).

The coal industry in the United States has been in a state of flux since the arrival of a cheaper alternative for energy production: natural gas. Exports are becoming a much bigger part of the domestic coal landscape, and Peabody Energy has deals in place to get its cheaper coal from the Powder River and Illinois basins to India, China, and the EU. For investors looking to capitalize on a rebound in the U.S. coal market, The Motley Fool has authored a special new premium report detailing exactly why Peabody Energy is perhaps most worthy of your consideration. Don't miss out on this invaluable resource — simply click here now to claim your copy today.

Piyush Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!

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