Coal Industry Stock Outlook - March 2014 - Zacks Analyst Interviews

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Overview

Coal plays a vital role in the economic development of a country. Coal not only provides a cheap source of electricity production but also creates employment opportunity for thousands of people. Coal with its heat generating capability also plays an essential role in the chemical, fertilizer and steel industries.

Coal is a dominant source of power generation worldwide despite the increasing use of other resources. Coal still plays an important role in the U.S. in the generation of power. However, natural gas and renewables are eating away its share at a rapid pace. The usage of natural gas and alternate sources for power generation will continue to pose challenges to coal.

According to estimates by the U.S. Energy Information Administration (EIA), the country's current coal reserves will last for 168 years at the present production rate. They might in all likelihood last even longer with environmental issues coming in the way. There is no denying the manifold advantages of coal. 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.

President Obama's Climate Plan, followed by the U.S. Environmental Protection Agency's (EPA) proposal for granting permission for setting up new power plants, is putting immense pressure on power producing units. In the light of these issues, if the U.S. electricity generators opt for natural gas for power generation and invest more in alternate sources, what will be in stake for coal companies?

Given the mounting environmental pressure, there is definitely a 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. Per the report, there were $12.3 billion worth of active coal projects in 2011, which declined to $7.5 billion in 2013.

Facts indicate 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.

On a global scale, coal still leads the way. There is hope for coal companies if they can produce high-efficiency coal. Technological advancement and carbon capture and storage offer possible remedies for coal's future.

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 91 out of 259 industries in our expanded industry classification. This puts the industry in the mid third of all industries, corresponding to a neutral outlook.

The way to look at the complete list of 259+ 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 18 companies belonging to the coal industry in our coverage 1 has a Zacks Rank #1 (Strong Buy); 1 has a Zacks Rank #2 (Buy), while 2 have a Zacks Rank #4 (Sell) and none are rated Zacks Rank #5 (Strong Sell). The other 14 have a Zacks Rank #3 (Hold).

Overall, the coal industry has been through troubled times in 2013, with some signs of improvement in 2014. Our Zacks Rank for individual stocks indicates the possibility of a gradual recovery in the industry.

Earnings Review and Outlook

The coal industry's overall earnings results in the fourth quarter were on the softer side. U.S. coal producers Peabody Energy Corporation ( BTU ), Alliance Resource Partners, L.P. ( ARLP ), Natural Resources LP ( NRP ), Alliance Holdings GP, L.P. ( AHGP ) and Cloud Peak Energy ( CLD ), among others, surpassed the consensus estimates.

In total, 55% of the coal companies in our coverage either met or came out with positive earnings surprises in the fourth quarter, below the 64.3% average for the S&P 500.

In 2013, the coal industry was impacted by lower realized prices and increasing usage of natural gas and renewable sources for power production. At the same time a supply glut in most regions were putting downward pressure on coal prices. Unavailability of railroad services impacted the operations of some miners.

The upcoming earnings releases in the first quarter are expected to remain soft as well. As per our current projection, Peabody Energy and James River Coal ( JRCC ) are expected to surpass year-ago earnings.

Coal operators have recognized that tough times are ahead and are adhering to stringent measures to improve their financial performance. Miners have taken initiatives to lower cost while engaging in tactful capital expenditures to assure the safety of mine operations. The miners are shutting down high cost coal mines and moving their operations to low cost regions. Longwall coal mining techniques are also having a positive impact on production.

A World Steel Association report suggests a 3.3% increase in global steel demand in 2014. This spike in steel demand might help met coal producers like Walter Energy Inc. ( WLT ) and Rhino Resource Partners L.P. ( RNO ) to boost profits.

Moreover, the demand for power fluctuates with seasons and a harsher winter or a more torrid summer may see higher demand for electricity and in turn more robust coal sales.

Coal Production & Consumption

Per an EIA report, U.S. coal consumption in 2013 was 923 million short tons (MMst), which is expected to go up by 4.6% 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 3.1% year over year to 936.1 MMst in 2015.

Per the EIA report, in sync with higher coal consumption, coal production in the U.S. will increase by 3.2% to 1,027.5 MMst in 2014. The production is expected to decline by 1.4% year over to 1,013.1 MMst in 2015.

Coal Trade

Per the same EIA report, U.S. coal exports in 2013 touched 118 MMst, 6.1% lower than export levels achieved in 2012. EIA pegs U.S. coal export at 103.3 MMst and 98.9 MMst in 2014 and 2015, respectively. The decline in export is a function of continued economic weakness in Europe 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 demand in the Chinese and Japanese markets, thereby posing a tough competition to U.S. producers.

Strengths

Coal as a major source of fuel for power generation dominates the utility industry. Coal is used to generate about half of the electricity consumed in the U.S. Electricity generation absorbs about 93% of total U.S. coal consumption. Apart from the utilities, coal is also used in various industries like chemicals, cement, paper, ceramics and metal products, to name a few.

Given its heat-producing feature, hard coal (metallurgical or coking coal) forms a key ingredient in the production of steel. Nearly 70% of global steel production depends on coal.

Demand for coal from the developing economies, primarily in the Asian countries, is a driving force for the industry. Of the emerging Asian countries, economic growth in China and India is touted to be the fastest. These countries rely heavily on coal for electricity generation. In 2013, Arch Coal Inc. ( ACI ) opened operations in Beijing to tap the growing metallurgical and thermal coal demand in South Asian markets.

Weaknesses

Coal is plentiful and fairly cheap relative to the cost of other sources of electricity, but its use produces emissions that adversely affect the environment. The sluggish pace of economic recovery and a supply glut have put downward pressure on the price of coal. EIA predicts average coal prices in the utility industry to decrease to $2.36 per million British thermal units (MMBtu) in 2014 from $2.38 per MMBtu in 2012.

The U.S. government has been pretty vigilant, enforcing stricter regulations on coal-fired generating units to curb pollution. The climate action plan from President Obama, followed by the EPA's proposal for implementing more stringent guidelines for setting up new coal power plants if diligently followed will increase the cost of producing electricity from coal, making it less attractive compared to other fuel sources.

Increasing competition from natural gas and alternate sources of power generation is gradually eating away coal's share in power generation. We expect to see more of this trend going forward.

To Sum Up

At present the top four coal producers contribute more than 50% of U.S. coal generation volume. Despite the stringent legislations and regulations regarding coal-fired generation, we still see some positive news for the coal industry.

The sudden increase in natural gas prices and an unrelenting winter to start off 2014 in most parts of the U.S. could have a positive impact on U.S. coal demand for the year.

The U.S. Bureau of Economic Analysis projects U.S. real GDP to grow by 2.6% in 2014 and 3.2% in 2015. Total industrial production is expected to increase 2.8% in 2014 and 4.0% in 2015. We find these forecasts promising, as we expect a significant portion of increased energy needs to be provided by coal.

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 unless strict environmental norms put coal out of business.

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 also 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.

We have also noticed a change in the product mix preference for a prime coal producer. CONSOL Energy Inc. ( CNX ). This traditional coal miner has shifted its focus to natural gas shedding most of its coal assets. The company has plans to divest additional coal assets. Will this be a new trend among the coal operators or just a stray example? Time will eventually reveal what is in store for the sector and its leading players.

For now, coal operators are taking due precautions to safeguard against freak accidents. However, a recent chemical spill into a river in West Virginia is a harsh reminder that pollution from the coal industry is an ever-present threat that can disrupt the living world.

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.

ARCH COAL INC (ACI): Free Stock Analysis Report

ALLIANCE HLDGS (AHGP): Free Stock Analysis Report

ALLIANCE RES (ARLP): Free Stock Analysis Report

PEABODY ENERGY (BTU): Free Stock Analysis Report

CLOUD PEAK EGY (CLD): Free Stock Analysis Report

CONSOL ENERGY (CNX): Free Stock Analysis Report

JAMES RIVER CL (JRCC): Free Stock Analysis Report

NATURAL RSRC LP (NRP): Free Stock Analysis Report

RHINO RESOURCES (RNO): Free Stock Analysis Report

WALTER ENERGY (WLT): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: EIA , ACI , AHGP , ARLP , BTU

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