EPA Threats Overblown, Coal Industry Still Has Legs

Last Monday, the Environmental Protection Agency proposed a new rule that would require a 30% cut in emissions from power plants. Stocks of some major coal companies, such as Arch Coal  (NYSE: ACI  ) , had been dropping for weeks in anticipation of such a move, and it sent them down even further.

Some were saying the 30% mandate was better than expected, and even in this new worst-case scenario, coal is going to remain roughly a third of America's energy generation. Yet the worst-case isn't written in stone, and there is ample reason to expect revisions.

Coal jobs: anything but minor
Despite a recent media emphasis on America's growing oil and gas production, coal remains a major part of the U.S. energy portfolio, and subsequently a major employer. Coal mining alone provides almost 90,000 jobs, and coal-burning power plants another 60,000. That's significant, but as anyone who lives in a small town with one major employer can tell you, it's only a small fraction of the indirect employment the industry provides.

That's particularly true in West Virginia and Kentucky, the largest coal-producing states. As you might imagine, that's got politicians from those states in both parties lining up against these rules.

As the elections near and some of those districts become "in play" for the narrow majorities in Congress, expect the question of coal jobs threatened by the EPA plan to become a big issue. Since President Obama is unlikely to want to drag down Democrats in these states, don't be surprised if the EPA proposal gets reviewed or further watered down.

The 2030 deadline was designed by the EPA in part to limit the immediacy of it as a political issue, but seems to be failing. If anything, it ensures that the plan will be an election issue every two years until then, with plenty of chances for lawmakers to kill it. When that cloud is lifted, expect a rebound.

An overview of big coal
The U.S. government has long talked about coal's "Big Four," covering the aforementioned Arch Coal, Cloud Peak Energy (NYSE: CLD  ) , Alpha Natural Resources (NYSE: ANR  ) , and longtime market leader Peabody Energy   (NYSE: BTU  ) .

All of these remain big players, and are worth considering as investments in the inevitable rebound. Alliance Resource Partners (NASDAQ: ARLP  ) and the smaller Rhino Resource Partners LP are also worth considering.

Buy the numbers
It's easy enough to say "buy coal," but as with any natural resource, not all coal miners are created equal. There is an obvious split between the still profitable companies like Alliance Resource, Rhino, and Cloud Peak, and the companies that have fallen out of profitability: Arch Coal, Peabody, and Alpha.

Earnings are always important, but doubly so in this case, as all coal miners carry substantial amounts of debt, and few have much cash on hand to weather a long-term storm.

Alliance Resource Partners yields about 5.5% annually. Naturally this has kept it from seeing the substantial price drop of some of the others, but as coal in general stops being shunned by investors, its position will only improve.

Cloud Peak and Peabody, by contrast, remain just on the cusp of profitability. Cloud Peak has something of an advantage in being just on the positive side of profitability, and carrying a comparatively small amount of debt, less than half its annual revenue. If/when margins improve, expect this to provide it more flexibility to grow. Peabody, by contrast, has the worst current ratio of the lot, and the most debt. Its traditional market leader position has protected its price somewhat, but if the EPA battle turns long term (which it may), it is in a worse position than the others considered here.

Alpha and Arch Coal are both seeing substantial losses, and as you might expect have lost the most market capitalization already. This lack of profitability makes both riskier plays, but both have larger than normal cash on hand, which should give them some wiggle room. Alpha seems riskier in this regard, as Arch Coal is not only a bit closer to profitability (with non-recurring expenses accounting for much of their recent losses) but has the largest current ratio of the whole bunch by far, meaning it has plenty of time to get their financial house in order. Arch Coal is also trading at only about 0.32 times book value, meaning if it can turn things around, it could be in for a substantial upswing.

Final thoughts
If you're an investor looking to add coal to your portfolio, I believe Alliance Resource Partners is an absolute must-have. I'm also a big fan of Rhino's high distribution, and I think a case could be made for taking a smaller position in Arch Coal to bet on a rebound.

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