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CONSOL Energy's Concentration on Gas Proves to Be the Right Move

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It's been several months now since CONSOL Energy (NYSE: CNX  ) has sold half of its coal business. The company sold five active coal mines in West Virginia that produced 26.7 million tons of thermal coal in 2013 and had 1.1 billion tons of coal reserves. The company's strategy is to focus on its natural gas business. Although natural gas prices are drifting lower to previous levels, this looks like a wise move from a long-term point of view.

Still no relief for the coal market
Thermal coal-heavy producers like Arch Coal (NYSE: ACI  ) and Peabody Energy (NYSE: BTU  ) are struggling to improve their profitability. Despite the harsh winter weather, there are no signs of major sustainable improvements of thermal coal prices. The market continues to suffer from overproduction, and it looks like this situation is not going to change soon. For example, while Arch Coal anticipates lower production levels in 2014, Peabody Energy plans to increase its production.

In such circumstances, coal assets would not have been the best cash generator for CONSOL Energy. The money from coal assets is better spent on deleveraging and growing the gas business. This is exactly what CONSOL Energy did. The company used as much as $2.4 billion from the sale proceeds to lower its outstanding obligations, while the remaining cash strengthened the balance sheet.

Gas production growth could help deleveraging
The company expects to grow its natural gas production by 30% this year. So far, natural gas production has been profitable for CONSOL Energy. The company's gas sales price averaged $4.26 per thousand cubic feet equivalent (Mcfe) in the fourth quarter, while average costs were $3.55 per Mcfe.

The cash flow growth resulting from the growth of production will help CONSOL Energy reduce its debt position, which currently stands at $3.2 billion. While the amount of debt looks reasonably low compared to fellow gas producers like Chesapeake Energy (NYSE: CHK  ) , which finished the fourth quarter with as much as $12.9 billion of debt, it needs further reduction to enhance shareholder value.

CONSOL Energy plans to dedicate $1.1 billion of its $1.5 billion capital spending budget on its gas producing segment, while the rest will be spent on its coal operations. This seems wise, as coal production is not expected to bring significant positive results in the near term. What's more, CONSOL Energy has also met coal production capacity. In current conditions, when met coal prices renew their lows quarter after quarter, allocating more money than needed for sustaining capital needs is a bad way of managing capital resources.

While CONSOL Energy has never stated this, it is possible that the company will ultimately get rid of its coal operations to turn itself into a pure-play gas producer. This is unlikely to happen in the near term, but if the coal price environment continues to be challenging, this is a possible option.

Bottom line
CONSOL Energy's move to decrease its coal exposure proved to be the right one. The company used the proceeds to lower its obligations and increase its cash position, which was very small prior to the sale of coal assets. As a result, the company is in a better position than it was prior to the deal. However, CONSOL Energy trades at 23 times its future earnings, which could be a rich valuation for a coal and gas producer in the current environment, so the upside is limited. 

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Vladimir Zernov

Vladimir Zernov believes that fundamental analysis works best with energy and materials stocks and covers them on Motley Fool.

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