A Must Buy Energy Stock

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The American energy company, CONSOL Energy (NYSE: CNX), produces coal and natural gas for the purpose of power generation and steel making. It is not only the largest producer of underground coal in the United States, but also the top producer of high BTU bituminous coal in the country.

Quarterly earnings

In the fourth quarter of 2012, CONSOL beat estimates and reported earnings of $150 million, or $0.43 per share, while analysts were expecting earnings per share of $0.24. Net income fell 23% to $150 million, whereas revenue fell 10% to $1.39 billion.

Cost per ton sold fell 8% to $48.21. The core reasons behind lower than expected costs included closing down of the high cost Fola mine in West Virginia, less overtime, and lesser maintenance projects. Net income slipped in the fourth quarter amid low met-coal prices, mainly due to lesser demand in Europe and China.

In 2012, the company sold $350 million worth of non-core coal assets in the U.S. and Canada. The company generated a pre-tax profit of $90 million from selling such mines in the fourth quarter. As low gas prices offset volume increase, CONSOL’s gas division reported net income of $9 million, almost flat from the earlier quarter. 

What’s in store for 2013-2014?

In order to reduce costs further, CONSOL Energy has plans of selling its high cost coal mines in 2013 as well.  According to the company, its costs at BMX mine in Western Pennsylvania are gradually decreasing, and will have the lowest cost per ton in 2014.  In 2013, the company has plans of investing $835 million-$935 million in natural gas wells. In the first quarter of 2013, analysts expect the company to earn $0.18 per share on revenue of $1.25 billion.

For the full year, analysts estimate CONSOL to earn $1.06 per share on revenue of $5.12 billion. 2014 estimates look really promising as the company is expected to earn $2.17 per share on total revenue of $5.89 billion.

U.S. energy outlook

According to the U.S. Energy Information Administration (EIA), record warm temperatures in 2012 were the chief reason behind low natural gas prices. As a result, energy companies shifted to natural gas instead of coal for power generation purposes. Given the fact that 2013 and 2014 are expected to have average winter temperatures, natural gas prices would see a slightly upward trend. Moreover, lesser coal demand in 2012 means high coal inventories on hand for 2013, putting a downward pressure on coal prices. Hence, thermal coal’s demand is expected to rise in the coming years.

(Source: www.EIA.org)

Valuation

Consol Energy is trading at a forward P/E of 14.12 and has a PEG ratio of 2.53. Incorporating a dividend yield of 1.6% into its PEG gives us a PEGY ratio of 2.06. According to the sell side estimates, it has a mean target price of $41, depicting the fact that it is an undervalued stock and has an upside potential of almost 28%. A mean recommendation of 2 on the sell side clearly suggests that it’s one of the top buys in its industry.

Industry’s major players

The American coal mining and processing giant, Arch Coal (NYSE: ACI), is the second largest coal supplier in the United States. Arch has 21 mines, and enjoys a 16% share in the domestic market. Analysts expect Arch to report a net loss per share of $0.33 in the next quarter. For the full year, it’s expected to incur a loss of $1.15 per share, showing the company’s weak position. Arch has a mean recommendation of 2.7 on the sell side, depicting that it isn’t an attractive buy at this stage.

The largest private sector coal company in the world, Peabody Energy (NYSE: BTU), engages in mining, sale, and distribution of coal. Last year, more than 46% of the company’s revenue came from its Australian mines. This year, Peabody has plans of investing more in Australia, where high met-coal prices and low production costs are expected to generate significant profit for the company. Peabody is trading at a forward P/E of 10.71 and has a dividend yield of 1.60%. A mean recommendation of 2.2 on the sell side makes Peabody Energy one of the most attractive buys in the industry.

Conclusion

As natural gas was cheaper than coal last year, power generating companies went for gas rather than coal. As a result, the coal industry suffered a major setback. However, CONSOL Energy’s efficient use of its low cost coal mines ensured that it kept on generating healthy margins. Going forward, the company would sell most of its high cost coal mines. EIA’s forecast for low coal prices relative to natural gas means that the company’s thermal coal business would see an improvement in 2013 and 2014.

Unlike its peers, which have been reporting negative earnings lately, CONSOL Energy has earned healthy margins. As the Chinese demand for metallurgical coal is expected to increase in 2012, met-coal prices are bound to go up. This means that the company is on track to mint healthier margins in the coming years. The bottom line is that CONSOL Energy is one of the most attractive buys in the energy sector, therefore, I definitely recommend buying it.


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