Is This Coal Market Trend Strong Enough to Save Producers?

Will the growing demand for coal be enough to help coal companies such as Peabody Energy and Arch Coal in the coming months?

May 30, 2014 at 9:07AM

The U.S. coal market heated up in recent months, mainly due to harsh winter conditions and the rise in natural gas prices. As a result, will coal companies such as Peabody Energy (NYSE:BTU) and Arch Coal (NYSE:ACI) benefit from the growing demand for coal? Let's further explore the latest shifts in the coal market and see how they may affect coal companies.

Rise in production
This year's winter has pushed up the consumption of electricity; this is likely to further rally the demand for coal. The U.S. Energy Information Administration projects that coal consumption will increase by 5% in 2014 compared to 2013. Despite the expected rise in consumption, the price of coal isn't expected to rise this year. These developments suggest that while the coal output may recover, this won't pressure up the price of coal. In other words, some coal companies may see a rise in production, but this won't improve their profit margins.

Some coal companies don't even expect to increase their output. During the first quarter of 2014, Arch Coal recorded a 1.5% drop in its coal sales (in tons); moreover, the company's operating margin fell from a $0.37 per ton loss to $1.61 per ton loss. This fall is due to higher cash costs and lower average price sale.

Peabody Energy hasn't done much better. Even though its total sales (in tons) grew by 7% during the first quarter, year over year, its U.S. operating profit margin per ton declined by over 14%. This decline has more than offset the rise in tons of coal sold. As a result, the company's revenue dropped by 7%.

One of the reasons we haven't seen a staggering rise in coal production among coal companies is the high depletion rate from U.S. coal stockpiles. During the 2014 winter (between November 2013 and February 2014), coal stockpiles plummeted by 24% to their lowest level in eight years. In the following quarters, however, the stockpiles are likely to rise due to an expected rally in production. Will this benefit coal companies such as Arch Coal and Peabody Energy?

Arch Coal estimates its annual coal sold (in tons) will reach an average of 135 million tons, around 3.5% lower than in 2013. In order to compensate for the low price environment of coal, the company is trying to reduce its cash costs. Its updated 2014 guidance shows a lower cash cost in its Appalachia segment compared to 2013. This improvement will still keep this segment at an operating loss, however.

Conversely, Peabody Energy plans to increase its production but only by 1.5% to reach 255 million  tons. Moreover, the company has reduced its operating costs in the U.S. by nearly 4%. On a yearly scale, it plans to maintain a 2% lower cost per ton compared to last year. Considering the price of coal isn't expected to rally, though, this modest cost reduction isn't likely to improve this company's bottom line.

The coal market is likely to keep heating up in the coming months as production picks up. Some coal companies such as Peabody Energy will see a rise in production and may benefit from these recent developments, but other companies such as Arch Coal will not. In any case, the expected rise in production isn't likely to pull up the price of coal. Therefore, coal companies are likely to keep showing lower earnings and little to no growth in sales.

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Lior Cohen 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.

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