Coal stocks have been the ultimate falling knife in the past year, confounding investors who thought that the value in this sector outweighed the negative news flow. One reason for the decline: Earnings estimates have fallen so fast that the stocks still haven’t reached attractive P/E ratios, even with their prices off anywhere from 40% to 70%.
A prime example is Arch Coal (NYSE:ACI). Ninety days ago, the stock closed at $15.58 — a loss of more than 50% from where it stood a year prior to that. The stock looked cheap, but this was just the beginning — in the 90 days since, 2012 estimates have fallen from $1.97 to 42 cents, while 2013 estimates have dropped from $2.41 to 13 cents.
The result? ACI now stands at $7.60, but it’s still trading for 17.6 times trailing results and 58.5 times forward estimates.
Coal stocks therefore remain a high-risk proposition, and it’s reasonable to expect that the sector will continue to underperform as long as the broader market is under pressure. Still, this is a group that has fallen so far that it is finally worth a look, even for those who have been bearish on the sector. And Arch Coal, in particular, looks to be the best way to play a rally. Consider the following reasons why ACI could deliver substantial upside in the not-too-distant future:
- Short interest: According to Yahoo! Finance, a full 21.9% of ACI’s float was sold short as of April 13, which would take 3.3 days to cover based on the average daily volume over the past three months. This indicates a high potential for Arch to deliver returns in the 10%-15% range over a one- or two-day period at some point in the weeks ahead.
- Sentiment is negative: This is a rare case where more analysts rate the stock a sell (1), underperform (4) or hold (14) than rate it a buy (7) or strong buy (4) — indicating that there is plenty of room for positive analyst activity on this stock.
- Price-to-book: While Arch Coal’s P/E ratio remains elevated, its price-to-book has collapsed to 0.45. This puts the stock at unprecedented levels relative to its own history and below competitors such as Peabody Energy (NYSE:BTU) at 1.37, Consol Energy (NYSE:CNX) at 2.04 and Walter Energy (NYSE:WLT) at 1.85.
- Capitulation appears to be at hand: While volume figures are being fueled in part by the stock’s falling price, volume in the selloff of the past six sessions has been far above the recent average. This is an indication that exhaustion might be close at hand.
- Technicals are oversold: That ACI would be oversold here should come as no shock, but the extent of the downturn has created some very interesting numbers. Arch shares closed Tuesday 25.2% and 44.5% below the 50- and 200-day moving averages, respectively, which are levels that have been surpassed very rarely in the history of the stock (aside from the 2008 crisis period). And although it’s hard to tell by looking at the chart, the current peak-to-trough decline of 79% is approaching the 86% decline registered during the stock’s catastrophic 2008 meltdown. Also, its relative strength index stood at the deeply oversold level of 22.3 at Tuesday’s close.
Add it up, and Arch Coal looks like a speculative buy despite the continuation of negative news flow. I’ve been bearish on coal since late last year (see here, here and here), but the extent of the recent selloff has finally caused the risk-reward trade-off to swing in favor of the coal bulls for the first time in nearly two years.
Disclosure: Daniel Putnam owns ACI shares and call options in his personal accounts. Jeff Reeves reported a similar purchase in his article 10 Editor’s Picks — What to Buy in May last week.
