Coal: Are These 4 "Black Sheep" Energy Stocks Worth Buying?

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Much is at stake in this election, nothing more significant than effects to our country's energy sector. Due to a combination of weak demand due to economic weakness, increased energy efficiency, inexpensive natural gas, and a mushrooming of growth in alternative energy, the heydays of coal, especially thermal coal, in this country is in the rear view mirror.

The difference between the two presidential candidates with regards to energy is stark. Obama is on record as endorsing 80% of its energy from “clean” sources by 2035. Of course, Obama's idea of “clean” includes natural gas and nuclear, putting the United States at getting about 55% of its energy from “clean” sources right now. Romney, during the first Presidential Debate in Denver, uttered “I like coal”, a comment that sent the Market Vectors Coal ETF (KOL) up nearly 11% in the week thereafter. Of course, those who would choose to invest in a coal ETF are likely not to be the same folks picketing to close the regional coal fueled power plant.

Often overlooked is that while natural gas did fall to a ten year price low of $1.91 per mmBTU in April of this year, it has bounced back of late to about $3.50 mmBTU, an increase in six months of 83%. That price is roughly identical with where it was a year ago, so to claim that natural gas prices have collapsed, is hardly as true as it once was. Further, I see far more upside than downside in gas prices in the years ahead. That is because the United States natural gas industry is insulated from world prices. In Japan, natural gas has been selling for between $13 and $15 per mmBTU, even after efforts this summer to wring excessive pricing out of the spot price. In Europe, prices have been hovering around $11 mmBTU. It is inevitable that global trade moderates the price of natural gas on a worldwide basis, forcing domestic prices to double or more their current level in the not too distant future.

Despite the considerable headwinds, Arch Coal (NYSE: ACI) reported a more or less successful third quarter. While revenue fell by 9% versus the third quarter of 2011 to $1.09 billion, GAAP profits rose fivefold, from $8.9 million, or $0.04 per share a year ago to $45.8 million or $0.22 per share in the just completed quarter. Metallurgical coal is struggling with the sluggish domestic economy, destitute European economy, and slowing growth in India and especially China. Thermal coal is confronted with over 150 planned new coal plants having been canceled in the past ten years, and the likelihood that 15% to 20% of existing coal plants in this country will be closed by 2016. In addition, Arch confronts the realities of the conversion of other plants to natural gas, and the real chance that we may never see any sort of renaissance of coal power generation. The survival of Arch will be hoping for exports, and in the meantime, cutting costs to match reduced demand. Its weak balance sheet, with a debt to equity ratio of 1.45, certainly does not help. I am not a fan.

Peabody Coal (NYSE: BTU) is the largest coal mining company in the world. Its' third quarter earnings came to $42 .9 million, or $0.16 per share, an utter collapse from last year's third quarter of $274.1 million, or $1.00 per share. The earnings failure came despite the fact that revenues actually increased marginally from last year's quarter. Adjusted earnings of $0.51 per share beat analysts' estimates of $0.34. As a result, Peabody's stock continued on a trend that has carried it up by 50% since early August.

Peabody posted adjusted earnings of $3.76 last year, and will be lucky to hit $2.00 this year. Analysts see earnings of $1.76 per share in 2013. It seems investors seem not to care about that downtrend, instead focusing on what they perceive as improving fundamentals. I see an America that will never again build a coal powered plant. I see a planet eager for cheap energy, and Peabody is on the forefront of sending American's declining coal use overseas to Asia. Yet China has made a serious commitment to wind and solar. I do not see a long term recovery of Peabody's profits, and for that reason I have no reason to recommend this issue, which already has been pushed to too expensive a price.

Unlike most coal companies, the stock of Natural Resource Partners (NYSE: NRP) has trended downward in general for the past twelve months. This limited partnership is not a coal mining company per se. Rather it owns coal and liquid energy producing areas, which it leases to mining concerns, and receives royalty income in return. Natural Resource sports a yield of 10.5%. So the attraction of this issue is obvious. Just as obvious is to ask, is this yield sustainable?

Natural Resource pays its distributions out of cash flow, not out of profits, even so, its guidance issued in the second quarter called for full year 2012 cash flow of $220 million to $240 million, equivalent to $2.08 to $2.26 per unit. That does not make me too sanguine about maintaining the current scheduled $2.20 payout for much longer, especially since 2012 is likely to be a better year for the company than 2013 will be. As slackened demand reduces the price of coal, there really is no escape for Natural Resources, other than hoping for something to stimulate demand for coal. Natural Resources did acquire rights to a sand mining operation that serves the hydraulic fracturing industry, but that is just nibbling at the edges. I have little doubt that Natural Resources will continue to pay a highly attractive yield; it just is likely not to continue to be as attractive as it is today.

Speaking of sinking ships, Alpha Natural Resources (NYSE: ANR) has been under a great deal of stress thus far in 2012, with no real end in sight. It took a $2.5 billion restructuring write down in the second quarter. With its balance sheet somewhat cleaned, it reported a loss of $46 million, or $0.21 per share in the third quarter. Adjusted for one-time items, Alpha lost $35.7 million, or $0.16 per share. Because analysts were expecting an adjusted loss of $0.44 per share, it this bizarre world of expectations versus reality, the stock was bid up about 8% the morning earnings were released. 

I see the company in a world of hurt. It bought back some of its 3.25% convertible notes due in 2015, and issued $500 million in senior notes due in 2018 with a 9.75% coupon. And it suffers the same fundamentals as other coal companies.

This is an industry in transition, if optimistic. Unless or until there are signs of the coal market recovering as a function of demand, and not just mining reductions, I would avoid the sector.


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