This Coal Play Shows Signs of Revival

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

Coal stocks have been one of the worst performers this year. The sector was pressured by low coal prices and massive debt levels of the companies. The first significant coal stock to report this season was Peabody Energy (NYSE: BTU). The company has beaten analysts’ estimates, reporting a profit instead of the expected loss. Is this the start of the revival?

Key takeaways from the report

The company has continued to aggressively manage its costs. The costs in U.S. and Australian operations were down 6% sequentially. Capital expenditure targets were reduced $100 million from $450 million to $350 million. Lower Australian dollar exchange rates also benefited Peabody Energy. Peabody states that it sees more improvement coming on the cost front.

Company’s revenues were down 13% from a year ago, which came as no surprise given current coal prices. Peabody Energy has managed to maintain a decent cash position, finishing the quarter with $517.9 million in cash on hand.

The company has commented on its coal outlook. This is interesting not only to Peabody shareholders, but for investors in other coal stocks like Arch Coal (NYSE: ACI) and the troubled Walter Energy (NYSE: WLT).

India’s coal generation was up 9% through June, leading to a 42% increase in thermal coal imports as domestic production struggles to meet the rising demand for coal. However, as one could see from the railroads’ reports, coal exports from the U.S. continued to struggle.

Japanese demand for coal is improving, as well as Germany’s. The reduction of nuclear power’s share in both nations is the likely reason for that. In addition, Peabody states that a lot of production is uneconomical at current prices. The company estimates that 45% of Shanxi producers are unprofitable. Shanxi is a Chinese coal-rich region. The reduction of the coal output would benefit coal prices.

What’s in the future?

Peabody has released bullish coal remarks before, but the prices are still low. This brings a lot of worry about the solvency of coal companies. Most coal producers are loaded with debt. The most notorious example is Walter Energy, a met coal play, which is down 60% this year. The company raised a lot of debt to acquire additional capacity back in 2011, when the coal prices were at their highs.

Walter Energy has recently provided its preliminary second quarter operating results. The met coal production would be up 7% quarter-to-quarter, while the cash cost of production is expected to decline more than 10%.

On the other hand, Walter Energy has announced that it's decreasing its quarterly dividend by 92%. This huge cut could be seen as a sign of liquidity problems. However, I wonder why it did not do it before. Paying dividends while having massive debt was taking vital cash from the company.

Arch Coal is another coal stock with a big debt. The company has more than $5 billion of debt. The debt schedule is relatively easy, and Arch Coal has time to get things going. The company has had around $1 billion in cash and short-term investments as of the end of the first quarter.

Solvency is not at question so far. Given that the company is expected to lose money this year and the next one, its dividend, which currently yields 2.86%, could be in question. It is possible that the move by Walter Energy could be just the beginning of dividend cuts in the coal sector.

Peabody states that it would finish the third quarter in the range of $0.16 per share loss and a $0.09 profit. The guidance mostly depends on coal prices. Given the company’s liquidity position, Peabody is solidly heading for the second half of the year.

Bottom Line

This was a solid report for Peabody. The company establishes itself as a leader in this challenging environment. Among notable coal plays, the company is the only one that is projected to deliver profits in the near future. Peabody is trading at 19.46 P/E and 0.94 P/B. The environment is still unfavorable, and risks persist. However, if you would like to establish a coal position, Peabody is a sure bet.

Walter Energy is one of the most risky stocks available on the market. The stock makes big price swings even intraday. I see the reduction of the dividend as a positive sign that management admits reality. However, I would like to see the cash position in the coming quarterly report before making statements about liquidity risks.

Arch Coal trades at 0.32 P/B, which is cheap. The company has a decent cash position. At the same time, the stock lack catalysts for growth, as the company is not expected to make money in the near future. 

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Vladimir Zernov 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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