Coal Industry Languishes, But All Is Not Lost

Overview

Coal plays a vital role in the economic development of a country. It is commonly used as a source of cheap electricity production. Coal also creates employment opportunities for thousands of people. Coal with its heat generating capability also plays an essential role in the chemical, fertilizer and steel industries.

This fossil fuel is still a dominant source of power generation worldwide despite the increasing use of other resources. Natural gas and renewables are eating away its share at a rapid pace, challenging the monopoly of coal.

There is no denying the manifold advantages of coal and its various byproducts that find use in the industrial sector. However, unchecked usage of this fossil fuel has raised concerns in all quarters. The primary cause of concern related to coal is global warming caused by the emission of greenhouse gases.

Recently, the U.S. Environmental Protection Agency (EPA) has proposed a Clean Power Plan, the primary objective of which is to cut down emissions from existing power plants by 30% over the 2005 to 2030 time frame.

Given the mounting environmental pressure, there is definitely a popular move away from coal as a power source. Per a report from Industrial Info Resources, active coal mining projects in the U.S. have declined by 39% from 2011 levels. The report says that such projects declined to $7.5 billion in 2013 from $12.3 billion in 2011.

Facts clearly indicate that the importance of coal is gradually waning in the U.S. Will investments in coal stocks fail to generate adequate returns?  Coal has lost ground for sure, but it is still a long way to go before it actually runs out of steam.

Response from the Coal Companies

Recent developments reveal that the coal companies are not ready to accept the EPA carbon plan without a fight. A lawsuit filed by Murray Energy Corporation has now been joined by nine states. Murray Energy claims that the EPA regulation will have a negative impact on thousands of jobs and hurt the American economy.

Zacks Rank

The Zacks Industry Rank, which relies on the same estimate revisions methodology that drives the Zacks Rank for stocks, currently puts the coal industry at 236 out of 260 industries in our expanded industry classification. This puts the industry in the lower third of all industries, corresponding to a negative outlook.

The way to look at the complete list of 260 industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, the middle one-third of the list (Zacks Industry Rank of #86 to #169) is neutral while the outlook for the bottom one-third (Zacks Industry Rank #170 and higher) is negative.

Please note that the Zacks Rank for stocks, which is at the core of our Industry Outlook, has an impressive track record going back years, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months).

Of the 20 companies belonging to the coal industry in our coverage 1 each has a Zacks Rank #1 (Strong Buy) and Zacks Rank #2 (Buy), while 9 have a Zacks Rank #4 (Sell) and 2 have a Zacks Rank #5 (Strong Sell). The remaining 7 have a Zacks Rank #3 (Hold).

Overall, the coal industry has been through troubled times in 2013, with hardly any respite seen in the first half of 2014.

Earnings Review and Outlook

The coal industry’s overall earnings results in the first quarter were on the softer side. Yet, U.S. coal producers like  Alliance Resource Partners, L.P. (NASDAQ:ARLP), Natural Resources LP (NRP), Alliance Holdings GP, L.P. (NASDAQ:AHGP), CONSOL Energy Inc. (NYSE:CNX) and Alpha Natural Resources, Inc. (NYSE:ANR) among others surpassed the Zacks Consensus Estimate.

In total, 36% of the coal companies in our coverage either met or came out with positive earnings surprises in the first quarter, way below the 67.8% average for the S&P 500.

The second quarter earnings releases are expected to remain soft as well. As per our current projection, nearly 50% of the coal companies under our coverage are expected to report in the red.

In response to the lackluster coal market fundamentals, the companies have resorted to stringent measures to improve their financial performance. Miners have taken initiatives to cut cost while engaging in tactful capital expenditures to assure the safety of mining operations. The high-cost coal mines are being shuttered while operations are moved to low-cost regions. Longwall coal mining techniques are also having a positive impact on production.

For a detailed look at the earnings outlook for the different sectors in our coverage, please check our weekly Earnings Trends report.

Coal Production & Consumption

As per the World Coal Association, proven global coal reserves will last nearly 112 years at current production rates. On the other hand, proven oil and gas reserves are projected to last around 46 years and 54 years, respectively, at current production levels. So, among the fossil fuels, coal has the chance to last longer.

Per an U.S. Energy Information Administration (EIA) report, U.S. coal consumption in 2013 was 924 million short tons (MMst), which is expected to go up 2.8% in 2014. The projected increase in coal usage in the U.S. is attributable to higher demand for electricity and the rising cost of natural gas. However, coal consumption is expected to drop 2.8% year over year to 924 MMst in 2015.

The EIA report also projects a 2.7% increase in coal production in the U.S. to 1,011 MMst in 2014. The production is expected to decline 0.9% year over to 1,002 MMst in 2015.

Coal Trade

Per the same EIA report, U.S. coal exports in 2013 touched 118 MMst, but it are expected to decline going forward. EIA pegs U.S. coal export at 99 MMst and 95 MMst in 2014 and 2015, respectively. The decline in export is a function of lower global demand and higher production from other coal exporting nations.

Besides Australia and Russia, which has the second largest coal reserve next only to the U.S., the U.S. coal exporters could face competition from Indonesia. Australia is trying to tap the demand in Chinese and Japanese markets, thereby posing a tough challenge to U.S. producers.

Key Coal Stock Picks

Alliance Resource Partners LP has a Zacks Rank #1 (Strong Buy), while its shares gained 20.1% year to date. The partnership registered earnings surprises in three of the last four quarters with an average beat of 12.23%. The long-term earnings growth projection is 6%.

The partnership operates 11 mining complexes in the Illinois basin and the Appalachian region. The firm produces a variety of coal from its mining complexes as per the requirements of its customers.

Existing long-term contracts with their customers provide visibility to Alliance Resource’s earnings stream. Its long history of increasing cash distribution also keeps investors interested in the stock.

Another coal operator, CONSOL Energy Inc. currently holds a Zacks Rank #2 (Buy) and its shares have gained 12.1% year to date. CONSOL delivered an earnings beat of 165% in the first quarter. The long-term earnings growth projection is 12%.

Though this coal company has shifted its focus to natural gas production, it still holds high-quality, low-cost mines. Despite selling a large part of its coal assets, total revenues of CONSOL consisted nearly 55% of coal revenues in the first quarter.

Production from its BMX mining complex could help the company to benefit from any revival in coal market demand. In addition, CONSOL’s increasing natural gas production volumes will ensure a strong performance.

To Sum Up

Currently the top four coal producers contribute more than 50% of U.S. coal generation volume. Despite stringent legislations and regulations regarding coal-fired generation, we still see some positives at play for the coal industry.

Coal companies could benefit from higher natural gas prices, reduction in stockpiles due to higher demand and a rebound in global steel usage. The World Steel Association forecasts that steel use will increase 3.1% to 1,527 Mt in 2014 and grow further by 3.3% to reach 1,576 Mt in 2015. The revival in steel demand could improve the prospects of met coal producers like Walter Energy Inc. (WLT) and Rhino Resource Partners L.P. (RNO).

The prices of coal can go up in the latter half of 2014 as the utilities will have to buy more coal to produce electricity and replenish their stockpiles. However, railroad services will have to deliver. Congestion in railroad services like it happened in the first half of the year could dampen coal prices.

Asia is the biggest coal market and presently accounts for 67% of the global coal consumption. China with its ongoing industrial development consumes nearly 50% of the total global coal. Industrialization in India is perking up, leading to higher coal consumption. Japan is also increasing its thermal coal usage following the nuclear aftermath and the deactivation of the reactors.

To take advantage of increasing coal demand from the Asian countries, premier U.S. coal producers like Peabody Energy (NYSE:BTU) and Arch Coal Inc. (NYSE:ACI) have opened operations in these regions.

Coal has a long list of drawbacks. But its advantage lies in its price, which is far cheaper than other sources of fuel. The availability of coal in most countries across the globe makes it a widely accepted source of power generation globally.

If we look at the global picture, it is evident that a cheap source of reliable power is a driving factor for economic development. Reinvigorating demand from growing economies and steady demand from the U.S. will continue to drive the coal industry in the future.

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