CSX's (NYSE: CSX ) domestic coal operations have gone from 24% of its business to 14% last year. At the same time, however, export coal has increased from 2% to 6%. Despite some headwinds on the export side, this railroad is a long-term believer in the potential of exported coal.
Another tough year
All of the railroads seem to be calling for another tough year for the coal market in 2014. That said, the domestic thermal market may actually be bottoming, with Bill Galligan, vice president of Investor Relations at Kansas City Southern, suggesting that 2014 will be the year the market reaches a "new normal." Basically, he thinks demand will stop falling. CSX is a bit more positive, expecting demand to pick up slightly after coal inventories are worked off.
The export business, where metallurgical coal plays a prominent role, is facing stiffer headwinds. Oversupply and weak prices have put U.S. met at a price disadvantage. That's worked out well for Peabody Energy (NYSE: BTU ) , which sells steel making coal almost exclusively out of Australia, but it's a big problem for Alpha Natural Resources (NYSE: ANR ) and Arch Coal (NYSE: ACI ) , which both mine met in the United States.
And metallurgical coal is a high-margin product, so the steep price drop has taken a big toll on Alpha and Arch. Arch is in a particularly tough spot because it materially increased its exposure to met at the peak of the market -- and it took on a lot of debt to do so. This pair will continue to suffer until the met market turns around.
Luckily for Arch and Alpha, Peabody has noted a firming in met prices, so the worst may be over. However, what's needed is an upturn, even at Peabody. The globally diversified coal miner has held up well, but low met prices are still a notable drag on the top and bottom lines.
That's why it's nice to hear Fredrik Eliasson, CFO of CSX, say that his company "believe[s] the U.S producers will play a larger role in the global coal market going forward." Although there's a thermal component to that, the near-term growth will likely appear on the met side. And there, data backs up CSX's belief and helps explain why the company has been so willing to give price concessions to keep U.S. producers in the export market.
According to the Association of American Railroads (AAR), coke (coal used in steel making) carloads were up over 8% through early December. On a more granular level, Union Pacific saw coke carloads advance nearly 3%, while CSX saw a whopping 22% increase. Norfolk Southern, however, saw a decline of 12% year over year. It's easy to see why CSX is so positive where other train companies are a little more tentative.
Starting to turn?
The thing is, if U.S. met coal needs stronger prices to remain globally competitive, the broad rail industry increase in car loadings is a potentially good sign. It could be a leading indicator that U.S. met will soon be profitable to export again—even if it means waiting until late 2014 or early 2015 for a notable bottom-line rebound at companies like Arch Coal, Alpha Natural Resources, and struggling Walter Energy (NYSE: WLT ) .
That type of recovery will be driven by a combination of cost cutting and still solid global demand working off the current supply/demand imbalance. In effect, that would be a "new normal" for met coal, using the words of Kansas City Southern's Galligan. So, if you are an aggressive investor, now could be a good time to start looking at domestic met miners.
Arch Coal and Alpha Natural Resources are reasonably strong operators, despite Arch's relatively heavy debt load. They are both good options and will benefit from a recovery in domestic thermal coal while waiting for international met markets to improve. Walter Energy is more risky since it's focused on met coal and, due to an ill-timed merger, also has a heavy debt load. Walter's upside, however, if you are willing to take on the risk, is probably the most impressive of the trio.
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