Are Coal Miners Mispriced?

Strong natural gas prices have helped push utilities back into coal, and coal miners have seen their stocks rise. As the saying goes, "a rising tide lifts all boats." The problem is that the market may be a tad too optimistic about a number of miners. Just because coal prices are coming back, it does not mean all miners will benefit equally. Before buying the whole coal sector, it is important to understand the differences driving each miner's bottom line.

The poor players
By looking at valuation alone it would be easy to mistake Arch Coal (NYSE: ACI  )  for a bargain. It is trading at a huge discount with a price-to-book ratio of 0.32 and a price-to-sales ratio of 0.24. The stock has some momentum and is above the lows set in July. The problem is that not all of Arch Coal's mines are profitable, and further writedowns in the Appalachia region look highly probable.

In the third quarter its operating margin per ton in its Appalachia segment was $-8.32. Its operations in the Powder River Basin and the Bituminous Thermal segments helped to decrease losses with operating margins per ton of $0.58 and $4.57 respectively, but the Appalachia is still a major drag on the company's profits. The Appalachia segment contains a number of high cost mines in the Appalachia region, and the whole area suffers falling productivity. Furthermore, the company has an enormous total debt-to-equity ratio of 1.88 that makes continued losses unsustainable. Arch Coal does not have substantial operations in Australia or in natural gas, making it a true short candidate.

Alpha Natural Resources' (NYSE: ANR  ) total debt-to-equity ratio of 0.72 is better than Arch Coal's, but Alpha Natural Resources comes with its own set of issues. In the first half of 2013 its Eastern Steam operations made up 35% of its total revenue. This is a major risk factor. Eastern U.S utilities are expected to shut down a large number of coal power plants in the coming years, and eastern coal is expensive to mine. 

Alpha Natural Resources is still running, but its exposure to eastern coal is a risk that investors should not ignore. The company has mitigated some of this risk through its metallurgic and western operations, but future write downs of its eastern operations would not be surprising. The company may look cheap with a price-to-book ratio of 0.31, but long term trends are not in its favor.

The other side of the coin
Management is a huge part of any successful firm, and in the future investors will look back at CONSOL Energy's (NYSE: CNX  ) decision to sell a number of West Virginian mines for $3.5 billion as a major turning point. Selling off a significant portion of a company is difficult, but this will allow CONSOL to rid itself of $2.4 billion in liabilities and push more funds into productive assets. Instead of trying to fight a war with cheap western coal and tough overseas competitors, CONSOL's management is willing to push the firm in a different direction; a positive sign for investors. 

At first glance CONSOL looks expensive as it trades at a price-to-book ratio of 2.15, but it is one of the few coal miners with a growth filled future. Its latest Q3 2013 data shows that its quarterly Marcellus production increased 72% year over year, and its recent asset sales will help the company plow more money to such growth.

Peabody Energy's (NYSE: BTU  ) price-to-book ratio of 1.16 puts it right between CONSOL's high valuation and the heavily discounted Arch Coal and Alpha Natural Resources. While Peabody does not have CONSOL's natural gas assets, Peabody does have a number of Australian coal mines. These mines are close to big Asian buyers like China and India, helping the company to decrease pressure from U.S. markets.

Fears over Chinese growth are alive and well, but Australian miners like Peabody have reason to rejoice. China is hoping to close down small local mines and support importers in the process.

While Eastern U.S. mines suffer from high costs, Peabody's management has structured its assets so that the company is not exposed to the Appalachia. With gross margins per ton of $16.36 in America's Midwest, $4.52 in the Western U.S. and $8.25 in Australia, the firm's Q3 2013 data is encouraging. Thanks to effectively placed mines, Peabody has a relatively easy time turning a profit.

Final thoughts
The coal market is coming back, and Arch Coal and Alpha Natural Resources have seen their shocks rise along with the rest of the industry. Even though their stocks have not risen as much as Peabody or CONSOL, the market may be a too optimistic. Arch Coal and Alpha Natural Resources do not have significant overseas operations or natural gas interests. These companies have large operations in high-cost areas, paving the way for more writedowns in the coming years.

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12/19/2014 4:04 PM
ACI $1.93 Up +0.17 +9.66%
Arch Coal, Inc. CAPS Rating: **
ANR $1.65 Up +0.12 +7.84%
Alpha Natural Reso… CAPS Rating: **
BTU $8.55 Up +0.46 +5.69%
Peabody Energy Cor… CAPS Rating: ***
CNX $34.88 Down -0.47 -1.33%
CONSOL Energy, Inc… CAPS Rating: ***

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