China gets much of its coal from Australia and Indonesia. Increased supply coupled with a slowdown in growth has left companies that serve the broader Asian coal market hurting. After cutting costs to the bone, however, some industry watchers expect thermal-coal prices to stabilize in 2014.
Roller-coaster of coal
When prices of any commodity rise, expansion becomes the name of the game. However, that ultimately leads to excess. Low-cost mines are expanded and mines that are marginally profitable get opened up. When prices inevitably come back down, the industry shifts to cost cutting.
For example, Joy Global (NYSE: JOY ) , which sells mining equipment, saw revenue and profits soar when commodity prices were high. Now, however, incoming CEO Edward Doheny notes that, "In the last 24 months, we've seen over 25 new CEOs at mining companies take over with a focus on cost reduction and returns to shareholders after years of focus on growth and investment."
According to the equipment maker, this shift has resulted in a 40% drop in capital spending at mining companies. That's obviously bad news for Joy and its shareholders, with fiscal fourth quarter sales down about 26%. Worse, orders for new equipment are down 36%. Fiscal 2014 is going to be another tough one for Joy.
Joy's trouble, however, is evidence of the correction. Thermal coal miners have been working hard to cut costs, including buying used equipment and curtailing expansion projects. That's why Xavier Jean of Standard & Poor's recently told industry watcher, and affiliated company, Platts that "persistent low prices will lead to production cuts."
Although the market may not be ready to turn higher, high-cost mines being closed is the key next step. And China has taken the lead here, pledging to close thousands of coal mines. Fewer mines will make it easier for thermal-coal players around the world to compete, including Peabody Energy (NYSE: BTU ) , Rio Tinto (NYSE: RIO ) , and BHP Billiton (NYSE: BHP ) .
Sticking it out
Of that trio, BHP Billiton has probably been the most successful at navigating the broader mining downturn. The company has a new CEO and has been working hard to cut costs, exactly the trend that Joy's Doheny highlighted. And, BHP's broad diversification has served it well since, unlike many of its peers, it's remained profitable through the broad mining downturn.
Similarly-diversified Rio Tinto is also on the cost-cutting bandwagon. Although write-offs pushed the bottom line into the red in 2012, the miner is another good starting point for more conservative investors. This pair has the financial strength and diversity to survive the current mining industry shakeout and to invest in growth again when the time is right.
However, while BHP and Rio are good companies, thermal coal isn't the main focus at either business. If you are looking for specific exposure to China and a focus on coal, Peabody Energy is the best option. With a large coal presence in Australia, just like Rio and BHP, and notable positions in the two lowest-cost coal regions in the U.S., a stabilizing thermal coal market in Asia will have a big impact on Peabody's top and bottom lines.
In fact, Peabody just inked a new deal in China to provide thermal coal. That puts it in a good position to gain market share in Asia as higher-cost mines are shuttered. And with the shares down notably over the past year, now is a good time to take a look.
Ahead of the curve
If you are looking to get ahead of the upturn in thermal coal, now is a good time to start looking. Diversified miners like BHP and Rio are a way to get exposure if you are conservative, but you'll have to wait for a broader mining upturn to really see the benefit this duo offers. That's going to happen eventually, but the thermal coal upturn that appears to be taking shape now will clearly be more of a benefit to coal-focused Peabody.
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