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4/13/2012 2:40:16 PM
After analyzing key trends for U.S. coal fundamentals over the next 12-24 months, and in conjunction with our global commodity team's natural gas forecast revisions, we are revising estimates for all the coal companies, and downgrading Cloud Peak Energy ( CLD ) and Consol Energy ( CNX ) from Outperform to Neutral. We reiterate our Outperform rating on Peabody Energy ( BTU ), given its growing Australia asset base and exposure to met coal.
Are We Near the Bottom? The most common question that we expect to get from our earnings revisions is given the ~50% decline in the sector over the past year and the ~20% decline YTD, whether or not all the bad news is finally priced into the earnings, and are the stocks now nearing a bottom. In our view, the answer is probably, and that is why we are not downgrading the sector to underperform. But in our view street expectations are still too high, and earnings cuts in our view will be a headwind near-term.
U.S. Thermal Coal Fundamentals Unlikely to Improve Until 2H'13: While we have seen significant production cuts year to date, we see 3 significant issues which will keep coal prices from moving higher over the next 12 months (and one of them is not low natural gas prices): 1) inventories, which we expect will remain well above levels of pricing power for the coal miners until 2H'13, 2) significant unpriced coal tonnage (50-55%) for 2013 and 3) spot prices which are at or below marginal cost, which suggests that 2013 contract negotiations will likely start at that level (ie: limited margin upside in 2013). The one bright spot is the export market, which will continue to grow after a flat 2012.
Still Expect a Met Coal Recovery: Conversely, we remain bullish on the prospects for met coal prices in the second half of 2012 (see full commodities team note for details). We believe the combination of 1) an acceleration in Chinese steel production, 2) supply constraints in Australia and 3) an improving global economy suggest that Q2 should mark the trough for met pricing in 2012. We again highlight BTU as our preferred way to play the met coal recovery.
Fairly Valued on Historical Valuations: On a historical multiples basis, we believe the coal stocks are fairly valued at our target prices, with only Peabody Energy ( BTU ) and Arch Coal ( ACI ) looking cheap on a relative basis vs. historical multiples (at a 10% discount to historical EV/EBITDA on our TP's).
Downgrading CLD, CNX to Neutral: Given the weak thermal backdrop, we are downgrading both Cloud Peak Energy ( CLD ) and Consol Energy ( CNX ) from Outperform to Neutral. Using the Credit Suisse HOLT framework tool also suggests both have limited upside from current levels. Reiterate Outperform Rating on Peabody Energy: Peabody Energy remains our top pick in the coal sector, due to BTU's 1) Attractive Australian Asset Base, 2) Volume and Earnings Growth to 2015 and 3) its position as a Long-term Option proxy for the PRB.