The Canary Is on Life Support and Coal Stocks Are Too

You've heard the story of the canary in the coal mine, right? Miners would bring a canary with them into the mine because if there were high levels of poisonous gases, the bird would meet its end before they would and the miners could escape before being harmed. The figurative canary died long ago, warning rough times were ahead for coal stocks, but some investors insist on pushing ahead anyway.

U.S. demand began to fall once the price of natural gas plummeted, old plants started to be decommissioned, and our hope for exports to China faltered when the country began aggressively pursuing its own mines.

The picture hasn't gotten any brighter recently. In the latest Electric Power Monthly report, the Energy Information Administration said that net generation from coal declined 21.3% in March 2012 from a year earlier. To put that in context, overall generation fell 2.9% and natural gas rose 40.2%, coming closer to edging out coal for the top generation source.

Coke demand hasn't picked up the slack for diversified producers either. China only imports about 10% of its coking coal supply, and despite being the world's largest producer, it will only import about 50 million tonnes of the 240 million tonnes of exports available last year, a disappointing development for exporters. The picture just doesn't seem to be improving quickly enough for producers.

Whose fault is it?
The industry would like to blame President Obama for the fall in coal's usage, but the biggest driver has really been natural gas. The EIA says that the price for natural gas electricity fell 7.5% in 2011, and with the price of natural gas likely to remain low for the foreseeable future, I don't see this trend changing. This has forced a big change in coal electricity generation. Since 2010, plant owners have said they will close 106 coal plants, so the industry is in for anything but a bounce in demand.

What's really killing coal is that plants are ancient, with over half built before 1967. The economics to build a new coal plant versus using natural gas and even renewable sources just doesn't make sense anymore, and power generators are abandoning the fuel source slowly but surely.

Even one of the biggest coal users, Duke Energy (NYSE: DUK  ) , has begun to turn its back on the industry, preferring cleaner, less costly forms of energy.

A value, or a value trap?
Despite falling stock prices, coal still has its backers. When I wrote an article on April 5 titled "It's Time to Abandon Coal Stocks," I was blasted by readers who thought I was crazy. Since then, the bottom has fallen out from under coal stocks, particularly Patriot Coal (NYSE: PCX  ) , Alpha Natural Resources (NYSE: ANR  ) , and Arch Coal (NYSE: ACI  ) .

PCX Chart

PCX data by YCharts

Even the top performer, Peabody Energy (NYSE: BTU  ) , has underperformed the market by nearly 12 percentage points after my CAPScall.

You may be able to look at these stocks and see some value. Price to book value looks attractive on some level, but the warning signs are still there.

Company

Price/Book

Return on Assets

Quarterly Revenue Growth

2012 EPS Estimate

Patriot Coal 0.4 (2.1%) (15.6%) ($2.21)
Alpha Natural Resources 0.3 2.7% 71.1%* ($0.99)
Arch Coal 0.4 3.5% 19.1%** ($0.43)
Peabody Energy 1.2 7.4% 17%*** $2.67

Source: Yahoo! Finance. *Alpha Natural acquired Massey Energy during June 2011. **Arch Coal acquired International Coal Group in June 2011. ***Peabody acquired Macarthur Coal in December 2011.

Revenue growth at three of the four was accounted for by major acquisitions during 2011, without which these companies would look even worse. Outside of Peabody, the hope for profit in 2012 has vanished, and even Peabody's estimates are falling quickly.

Now is not the time for a value play
Coal is the past in energy, and while it will play a role in making steel, I don't see this driving stocks forward in the near future. More plant closures will surely take place in coming years, followed by mines closing, and financials will continue to get worse.

There's simply no reason to hang on to coal stocks right now, and certainly no reason to build a new position. The 20th century is over, the canary has died, and coal stocks are on their way out too.

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Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (6) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 31, 2012, at 11:45 AM, Borisbmx wrote:

    interesting because world usage of coal rises every year.

  • Report this Comment On May 31, 2012, at 12:10 PM, Usurped wrote:

    Maybe the author is a Sierra Club Papa Doc Barack Liasion.

  • Report this Comment On May 31, 2012, at 3:13 PM, William163264 wrote:

    Easy to see a downward trend and say it will continue downward. Saavy investors rely on a supercycle. Coal is not done by any means. This article does not tell us anything we don't already know.

  • Report this Comment On May 31, 2012, at 4:47 PM, TMFFlushDraw wrote:

    @William163264

    How is coal entering a supercycle? Every energy trend is moving against coal.

    Travis Hoium

  • Report this Comment On May 31, 2012, at 5:08 PM, KurtEng wrote:

    "The economics to build a new coal plant versus using natural gas and even renewable sources just doesn't make sense anymore, and power generators are abandoning the fuel source slowly but surely."

    The same could have been said with natural gas and coal switched 10 years ago. The long term picture really hasn't changed, and that is that America has a lot of coal and not so much oil. The energy supply will continue to shift away from oil to coal and natural gas. Right now, natural gas has the usage momentum with transportation and electricity production adopting it, but that WILL eventually drive up the price of natural gas, possibly faster than many expect. Coal demand will rebound.

  • Report this Comment On May 31, 2012, at 5:23 PM, patrikor wrote:

    *shrug*

    Look at the numbers. (Down.) Consider the domestic natural gas situation. (Plentiful and cheap.) Sure, world wide coal usage increases, but is it increasing here? (No.) Will China buy ours? (Seemingly not.) Who's going to pick up the slack? We're the biggest two coal using nations by far. Coal isn't going anywhere, but it might be a long wait to get a return on your investment.

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