Coal Stocks Could Surge With the Plunge in Natural Gas Inventories

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

The biggest beneficiary of plunging natural gas inventories might not be a company in the natural gas industry. The coal industry took a big hit due to the suddenly abundant and cheap energy source developed over the last decade. Coal stocks are arguably among the most hated stocks on the planet. 

Stocks such as Peabody Energy (NYSE: BTU  ) and Arch Coal  (NYSE: ACI  ) will benefit, however, the most from a switch back to coal as a fuel source for electricity production. Alpha Natural Resources (NASDAQOTH: ANRZQ  ) might provide the most upside, especially if investors see a global rebound that increases the demand for metallurgical coal used in steel production. In general, the sector has been crushed so much in the last couple of years that any snap-back in demand will raise all the stocks in the sector.

Natural gas inventories plunging
While coal stocks surged an average of 5% last Friday, the majority of these companies still trade around multi-year lows, trading in stark contrast to the surging price of natural gas to levels above $4/btu. This price level will encourage a switch back to coal by some power plants.

Even more encouraging for the coal stocks was the weekly release by the EIA that natural gas inventories plunged 177 Bcf for the week ending Dec. 20. Inventories now sit at 3,071 Bcf, or 177 Bcf below last year's levels at this time. Inventories are now 9.2% below the five-year average of 3,384 Bcf, further increasing the possibility that natural gas prices could surge in the short-term.

Focused on thermal coal
Peabody Energy is the leading domestic coal producer with a market cap of $5 billion and revenue in excess of $7 billion. The company is also rare in that it continues to be profitable and generates EBITDA margins around 17%. Like the industry, though, Peabody continues to see revenues decline due to lower prices. The good news is that it was recently able to reduce U.S. unit costs to three-year lows, providing for increased margins when prices do rebound. At an expected annual adjusted EBITDA level of around $1.1 billion, Peabody trades around 4.7 times that forecast.

Arch Coal now has a market valuation below $1 billion with the stock trading around $4.50. Only a few years back, the stock was trading for over $30, showcasing the level of collapse in the coal sector. Arch recently raised $423 million in net cash proceeds from selling its Canyon Fuel subsidiary. This asset sale provides the company with plenty of cash to survive the pricing collapse of coal.

Arch primarily focuses on thermal coal production in the Powder River Basin, or PRB, along with smaller operations in the Appalachian and Illinois Basin. The Appalachia segment produces a mix of metallurgical coal that provides a significantly higher average sales price, making the relatively small production of 3.3 million tons an important second priority to the PRB.

Metallurgical coal leaning
The financial picture at Alpha Natural improved recently with the announced agreement to sell the 50% interest in Rice Energy for $200 million of Rice common stock and $100 million in cash, for total consideration of $300 million. The IPO for the natural gas producer in the Marcellus shale should occur sometime in early 2014. Even more interestingly, Alpha is only selling interests in 7,500 acres in the Marcellus shale with 10,000 acres remaining. Remember that Alpha only has a market cap of around $1.6 billion.

Though Alpha will benefit greatly from a rebound in thermal coal demand in the U.S., it benefits greatly from global metallurgical coal demand. For 2014, it guided demand at around 20 million tons of Eastern metallurgical coal and 26 million tons of Eastern thermal coal. Alpha has 41% of the thermal coal and 97% of the metallurgical coal unpriced at the end of the third quarter, providing for substantial upside based on an improving pricing situation.

Alpha generated revenue of nearly $7 billion in 2012 and now sits with a valuation for the coal assets of only $1 billion.

Bottom line
The dramatically lower natural gas inventories set up the coal stocks for a surprising rally, likely catching most investors off guard. The above stocks stand to benefit the most from improving demand for coal. Peabody Energy is the safe bet with the market-leading position, and Arch Coal will benefit the most from increasing thermal coal demand. Alpha Natural remains a wildcard coal miner that will benefit from increased thermal coal demand, but investors should buy this one based on expectations of growing metallurgical coal demand in Europe and Asia.

The Motley Fool's Top Stock for 2014
There’s a huge difference between a good stock, and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it’s one of those stocks that could make you rich. You can find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.


Read/Post Comments (1) | Recommend This Article (3)

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 January 02, 2014, at 4:49 AM, Jade007G wrote:

    Interesting article ! Agreed that any downward revision in shale gas reserves could further increase prices.

    US seems to be only place with abundant Shale Gas reserves at relatively lower prices. Rest of the world can't even imagine generating power from natural gas. In Europe nat gas prices are above $8 and in Japan $16.

    However with prices above $4 in the US, coal seem to be more cost effective source.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2780357, ~/Articles/ArticleHandler.aspx, 8/31/2015 4:52:27 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Mark Holder

Mark has been writing for TMF since Dec. 2012 with a primary focus on taking advantage of opportunities provided by the market in the energy and tech sectors.

Today's Market

updated 2 days ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:00 PM
ACI $8.21 Up +1.18 +16.79%
Arch Coal, Inc. CAPS Rating: **
ANRZQ $0.05 Up +0.01 +38.00%
Alpha Natural Reso… CAPS Rating: **
BTU $2.39 Up +0.11 +4.82%
Peabody Energy Cor… CAPS Rating: **