3 Scenarios That Could Send Metallurgical Coal Miners Higher

There's blood in the streets for the metallurgical coal sector, but here are three scenarios that would send metallurgical coal stocks higher.

Mar 14, 2014 at 9:13AM

Metallurgical coal miners Walter Industries (NASDAQOTH:WLTGQ) and Alpha Natural Resources (NYSE:ANR) are trading at prices not seen in 10 years. There is blood in the streets as the sector contends with oversupply caused by new Australian mines coming online. The two companies are both unprofitable and sentiment is very negative. 

As an investor looking for potential positives, are there any potential scenarios that could send shares higher in this environment?

The Bowen Basin floods
In 2011, Australia's Bowen Basin, which produces roughly a third of the world's metallurgical coal, experienced floods that caused metallurgical coal prices to spike from $200/MT to $330/MT. 

If a flood of similar magnitude occurs, metallurgical coal stocks could spike again. Meteorologists estimate that a flood of this magnitude occurs once every 25 to 50 years. 

The Australian dollar appreciates significantly to the U.S. dollar
The Australian dollar is highly dependent on the health of China's economy because Australia exports significant amounts of commodities to China. Because China's economy has weakened over the past year, the Australian dollar has depreciated approximately 13% to the U.S. dollar over the last 12 months.

The Australian dollar's depreciation has made Australian coal cheaper than American coal. If the reverse occurs and the Aussie appreciates significantly, U.S. coal exports will be more competitive. This event is unlikely in the near term, however, because U.S. interest rates are rising while China's economy is still contending with a bursting credit bubble.   

Miners beat expectations in lowering costs and restructuring debt 
In the face of large annual losses, Walter Industries and Alpha Natural Resources have tried to cut costs as much as possible.

Walter Industries cut capital expenditures from $392 million in 2012 to $154 million in 2013. It decreased SG&A costs by 25% year over year and cost of production 18% year over year. 

The company plans to further reduce SG&A by 20% this year. 

Similarly, Alpha Natural Resources cut capital expenditures from $498 million in 2012 to $257 million in 2013. It reduced SG&A from $209 million to $159 million in 2013 and is targeting around $200 million in cost cuts this year. 

Both companies are trying to restructure debt to give them more runway space.  

Even with the cost cuts and debt restructuring, analysts do not see any profits for Alpha Natural Resources or Walter Industries over the next two years. Because expectations are very low, if the companies surprise on the magnitude of cost reduction, their stocks may rally.

The bottom line
Goldman Sachs does not see the metallurgical coal oversupply issue resolving itself for another couple of years. The investment bank, in fact, lowered its metallurgical coal price forecast from $150 a metric ton to $141 a metric ton and cut its price target on both Alpha Natural Resources and Walter Industries. 

Diversified, low-cost producers such as Australian BHP Billiton (NYSE:BBL) are much better positioned to weather the storm. Unlike its American counterparts, BHP Billiton is profitable and in solid financial position.

The American metallurgical coal industry may see more pain ahead, but eventually demand from China, India, and Brazil will soak up the excess supply. If Walter Industries and Alpha Natural Resources can cut costs and sell assets enough, they will be able to survive and see better times ahead.

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