Is Coal Set for a Comeback?

Peabody Energy is a great way to play the rebound in coal.

Jun 2, 2014 at 1:58PM

After years of stagnation and falling volumes, the coal market is finally starting to show some signs of life. This comes not a moment too soon. Coal companies have had a terrible year to date, with Arch Coal (NYSE:ACI) down nearly 29% and Peabody Energy (NYSE:BTU) down around 20%.

Unfortunately, these declines are only a snapshot of the past five years which have been crippling for the coal industry. Over this period, Arch's share price has crashed 80%.

Still, some green shoots are appearing in the market. This is leading to claims that a bottom may have formed in the market, thanks in part to the winter weather. Are these miners about to get a period of respite as coal prices begin to rise and demand increases?

Getting better
According to analysts at Morgan Stanley, things could be getting better within the coal industry for several reasons.

Firstly, the extreme weather over the winter has depleted coal inventories. This has led to inventory levels falling below the 100 million ton level. Stockpiles have not fallen to a level this low since 1997.

Secondly, as the demand and price of coal has fallen on the open market during the last few years, production volumes have slumped within the U.S. Falling production volumes should cap the supply of coal.

That being said, some industry headwinds remain. These include the low price of natural gas and the EPA's Mercury and Air Toxics Standards, which are likely to force coal plant retirements.

However, there are reports that producers are noting a higher demand for coal, with strong year-on-year demand increases. Some reports place these increase in the region of 30%.

The way to play it
With a notable rise in demand, those willing to take the risk could find that it's time to get back into the coal market again. One of the better picks for this market is Peabody.

Peabody's main advantage over peers like Arch is the company's lower level of gearing. This gives it more flexibility when it comes to surviving a downturn in coal prices and executing turnaround plans.

At the end of the last reported quarter, Peabody had a debt-to-equity ratio of 1.5, compared to Arch's ratio of 2.4. Arch's financial leverage stood at 4x compared to 3.5x for Peabody.

What's more, taking a quick look at Arch's debt maturity dates it would seem as if the company's debt is repayable from 2016 to 2028, with the bulk falling around 2020. The bulk of Arch's debt falls due during 2019, so the company is going to have to find plenty of cash quickly to avoid breaching its credit obligations .

Peabody also has exposure to both meteorological and thermal coal, as well as low-cost production. This should help it going forward.

Foolish summary
Overall, there are some signs that the coal market is making a recovery. Any recovery is likely to be slow and tentative, however. With this in mind, it would appear that the best way to play the rebound is via Peabody.

Peabody's size and low level of gearing mean that the company is well placed to turn a profit if coal prices start to rise again. Arch, on the other hand, is poorly positioned and is likely to find it tough to turn things around.

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Rupert Hargreaves 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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