The domestic thermal coal industry has been in the doldrums for several years, but there are signs of life taking shape. For example, Powder River Basin (PRB) coal prices are at their highest point since late November of 2011. That's good news for Cloud Peak Energy (NYSE:CLD) and Peabody Energy (NYSE:BTU).
U.S. thermal coal has been hard hit by a combination of low natural gas prices and its dirty image. For several years gas has been price competitive for power generation and, because it burns more cleanly, has been favored over coal. For example, in 2013 gas powered over half of the new electric capacity built. Coal powered just over 10% and was added in only two states, Texas and Indiana.
In 2012, natural gas was so cheap that power companies used it over coal even for existing power plants. This led to a buildup of coal inventories, reduced coal demand, and downward pressure on coal prices. For example Cloud Peak's U.S. coal volumes fell 5% in 2012 and another 5.5% last year, and that came on top of weaker pricing. It's not surprising, then, that earnings have fallen from over $3 a share in 2011 to $0.85 a share last year.
That said, 2013 saw natural gas prices rise and excess PRB inventories burned off. At the start of 2014, the U.S. Energy Information Administration noted the shift, saying that the trends supported, "...greater demand for delivery of PRB coal."
Finally, a bright spot!
Internationally diversified coal miner Peabody Energy put some numbers to this during its fourth quarter conference call, when CEO Gregory Boyce noted that, "...PRB prices were up nearly 40% from their lows of last year."
Peabody's PRB operations accounted for nearly 40% of the top line in 2013. So an upturn in prices for PRB coal is a big deal. In fact, Peabody produces over 4.5 times as much coal from its PRB mines than it does from its next largest business segment, Australian metallurgical coal. So, even small price increases have a lot of leverage behind them.
Although 2014 is likely to be another difficult one for Peabody, an uptick in the PRB will help soften the blow from continued pricing weakness in the met market, where margins are more important than volume. It also hints that the downturn in the U.S. thermal market may be coming to an end. If that's true, Peabody's Illinois Basin assets (about 20% of sales) could start seeing notable improvement as well.
While $4.7 billion market cap Peabody may be the largest and most diversified coal miner, the purest play on a PRB turnaround is $1.3 billion market cap Cloud Peak Energy. The company, which produces about half as much coal out of the PRB as Peabody, only mines in the one region. While Peabody has posted losses of about $2 a share in each of the last two years, Cloud Peak has managed to keep its head above water throughout the coal industry's darkest days.
And it's a heck of lot easier -- at least mentally -- to own a coal miner that's making money while you wait for supply and demand to balance out than it is to own one that's losing money. So even though Peabody is a global coal giant, which provides clear diversification benefits to investors, Cloud Peak's singular focus will likely lead to a quicker turnaround and has made investing in coal more palatable.
Not out of the tunnel yet
Coal is hardly out of the tunnel, but PRB pricing hitting two year highs isn't just a glimmer of light at the end—it's more like a spotlight. The best way to play the trend is PRB-focused Cloud Peak Energy. However, if you want to play both the PRB upturn and the potential for a longer-term turn in coal, which is still a ways down the line, Peabody Energy is the better choice.
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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.