Now Is the Time to Focus on Coal Companies

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

Coal remains unloved because it is considered a dirty fuel. However, changes in the market are beginning to alter the fuel's outlook for the better. It's time to rethink the industry.

The invisible hand

Markets are guided by a so-called invisible hand in which reasonably rational individuals do what is in their own best interests. In the end, supply and demand come together to create a working ecosystem. That's happening to coal in spades.

New methods of drilling for natural gas overtook demand for the fuel and led to a steep price decline. That led utilities, the largest users of coal, to switch to gas as a fuel source to keep costs down. Coal demand and pricing fell as a result. The coal industry reduced production and refined operations as a result.

Natural gas prices, however, were so low that drillers couldn't make money drilling. Natural gas drilling has, thus, slowed. That has pushed gas prices notably higher to the point where the choice between coal and gas as a base load fuel is no longer tilted in favor of gas.

The invisible hand is an incredible thing. And there are other long-term positives for coal, too.

New and old

Peabody Energy (NYSE: BTU) recently noted that it expects new coal fired power plants built around the world to increase coal demand by 1.4 billion tonnes by 2017. However, that positive is offset by the fear of U.S. government regulation forcing older domestic plants to shutter. Only Arch Coal (NYSE: ACI) highlights that U.S. coal fired power plants operated at 73% of capacity in 2007, but at just 54% last year. So, any closures could easily be made up by demand from increased utilization.

Increased utilization is a price issue as utilities look for the lowest cost fuel source. Coal and natural gas will continue to vie for market share, but the negative trends in coal appear to be abating. And it looks like a few solid long-term positives are lining up. Now is the time to start looking at coal, even though 2013 could be another difficult year.

The global player

Peabody is one of the largest U.S. coal miners, but it has a global profile. Notably, it has operations in Australia which allow it to easily provide coal to Asia. Coal demand in China and India is increasing rapidly, so this is a key long-term benefit.

The company remained solidly profitable until 2012, when profits fell dramatically. However, the loss is largely the result of one-time costs, including non-cash asset impairment charges. Without those charges, the company would have earned over $2.60 per share. This explains why, despite the difficult year, the company didn't cut its dividend. As the coal market improves, Peabody is well positioned to take advantage of the recovery.

It offers a yield of around 1.80%, relatively low on an absolute basis, but high for Peabody.

Number two

Arch Coal is another large U.S. coal producer. It doesn't have the global assets of Peabody, but is working to expand its ability to export coal from the United States to the countries where demand is increasing most quickly.

Like Peabody, Arch had been solidly profitable until 2012 when it posted a steep loss. However, that was directly related to a non-cash impairment charge of $231 million “due to the decline in benchmark metallurgical coal prices versus 2011.” While the company still lost money for the year even after removing the one-time charges, it has plenty of financial liquidity.

The company's yield is around 2.30%, but the tough market led to a large dividend cut. That's a notable risk, but also provides potential upside for income seekers. As results improve, the dividend here is more likely to ratchet higher than at Peabody.

A middle ground

CONSOL Energy (NYSE: CNX) is a good middle ground for investors who don't want to bet too heavily on coal as natural gas becomes an increasingly important fuel source. The company is a major coal producer, but also has notable natural gas operations, too.

That's been a major benefit through the difficult pricing period for coal, allowing CONSOL to remain profitable in 2012. The company also managed to increase its dividend slightly last year, which shows the strength of its dual commodity focus. The recent yield was around 1.40%. However, unlike Peabody and Arch, the shares haven't traded lower this year. So, the turnaround appeal on a coal rebound is notably reduced.

<img alt="" src="" />

BTU data by YCharts

Coal isn't dead

Coal is being treated like it is never going to be used again. That's simply not true and there are some good options in the space for more aggressive investors. Peabody is the most globally diversified option, Arch's dividend cut could provide upside to its yield on a coal recovery, and CONSOL is a safe punt option because of its gas assets.

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.

Reuben Brewer 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!

blog comments powered by Disqus