How to Play a Coal Rebound

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Blame it on abundant natural gas supplies, but the coal industry is having a terrible year. New advances in horizontal drilling have created a glut of supply not seen in decades. With prices for natural gas hovering around the sub-$3 MMBtu mark, a variety of utilities have switched over to the cheap fuel rather than burn coal to produce electricity. Add this to lower demand from Europe thanks to weak economic conditions, and it’s no wonder why shares of thermal coal producers have sunk during the past few weeks.

However, there are two sides to every coin, and coal is no different. For investors, the metallurgical coal (i.e. steel) producers have been taken a beating just as well but could offer real long-term value at their current valuations.

Idling Mines & Bullish Outlooks

Coal miner Alpha Natural Resources (NYSE:ANR) became the latest producer to idle some operations as demand for coal continues to wane. The company expects to reduce its annual coal production by about 4 million tons, and overall, Alpha plans to shutter four mines immediately and an additional two by early 2013. The company joins Patriot Coal (NYSE:PCX), which recently idled its Big Mountain complex in West Virginia. The culprit behind the closures: utilities switching to cheap, abundant natural gas.

Natural gas prices recently have plunged to their cheapest levels relative to coal since 2009. The fuel is quickly growing as the go-to replacement to coal for power generation as advances in new drilling techniques have created an abundance of supply. In addition, some major power producers like Duke Energy (NYSE:DUK) have begun shutting down many of their legacy coal-fired plants in response to stricter environmental rules. Natural gas is getting the nod from the EPA as a cleaner-burning alternative to coal, and the cost of converting a coal plant to natural gas is relatively inexpensive compared with potential fines down the road. Plus the cheapness of natural gas makes converting plants all that more ideal.

The thermal coal producers are seeing problems from another source as well. Slowing economic conditions in Europe are helping to stem export volumes. Coal exports to Europe accounted for around 7.5% of total production in 2010. As the continent begins to enter a recessionary phase, these exports have cooled. Slowing growth in China also has dwindled export volumes for U.S. coal producers.

However, it’s not all bad news for the coal producers. Metallurgical, or coking, coal — the kind used in steel making — is estimated to continue seeing strong demand for the rest of the year. Global steel production remains upbeat and grew 1.3% in January. Rising U.S. manufacturing coupled with emerging-market infrastructure spending will help buoy softening demand from Europe.

As one top producer of coking coal, Canada’s Teck Resources (NYSE:TCK) saw a surge in its fourth-quarter profit due to higher metallurgical coal production and prices. The company realized an average coal price of $253 per ton in the fourth quarter and forecast 2012 metallurgical coal production of around 25.5 million tons — a solid increase over 2011’s 22.8 million tons. Given the bullish state of metallurgical coal demand, Teck actually is considering reopening its Quintette Mine in British Columbia.

Teck isn’t the only one bullish on coking coal. Analysts at Credit Suisse (NYSE:CS) predict that “… met-coal prices could find a bottom in the second quarter, which will suggest a recovery in some of the hardest-hit met-coal producers.” Credit Suisse points to continued growth in the global steel markets as the commodities major catalyst.

The Contrarian Play

Despite the major differences in pricing and usage, the majority of the metallurgical coal producers have traded downward right along with their thermal twins. For investors, there is plenty of potential in playing that spread. Low natural gas prices should keep a lid on the thermal producers, while the coking coal firms should benefit from long-term steel-making trends.

Previously mentioned Teck Resources makes an interesting all-around commodity play as it has holdings in copper, zinc and oil sands assets in addition to metallurgical coal. But there are other great values out there as well.

Mega-producer Peabody Energy (NYSE:BTU) could be a great choice. The firm has seen its share price fall from a high of around $73 to its current $35, as its coal supplies 10% of U.S. electricity production. However, Peabody quickly is becoming a metallurgical coal powerhouse, too. In December, the company purchased a 5.1% equity interest in Winsway Coking Coal Holdings. The Mongolian firm is one of fastest-growing exporters of metallurgical coal to China. Peabody’s purchase of Macarthur Coal gave it solid coking coal holdings as well.

Peabody also trades at 9 times earnings, which is less than many of its peers, such as CONSOL Energy (NYSE:CNX) at 13. So for investors, Peabody’s recent moves toward shifting its thermal-to-metallurgical mix make it a great — and inexpensive — choice for a coal rebound.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.


Article printed from InvestorPlace Media, https://investorplace.com/2012/02/thermal-metallurgical-coal-energy-stocks-to-buy-tck-btu/.

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