Is CONSOL Energy a Buy?

Timing can be everything. It certainly made a difference when CONSOL Energy (CEIX 1.84%) completed its spin-off from CNX Resources, which was confusingly previously named CONSOL Energy. The new spin-off is flying under the same flag, but it took all of the former parent company's coal assets. With the American coal industry experiencing an awakening of sorts, the stock has jumped nearly 50% since relisting.

The sudden appreciation in value could mean any number of things. Perhaps CONSOL Energy was undervalued at the time of its spin-off. Perhaps it earned a higher valuation, or has convinced Wall Street that the business is poised to thrive in the near future. Or perhaps this is the latest example of an irrational market, and the coal company is overvalued.

What do the numbers indicate? Is CONSOL Energy a buy?

Image source: Getty Images.

The business

CONSOL Energy owns three primary assets: the low-cost Pennsylvania Mining Complex (PAMC) with 735 million metric tons (MT) of reserves, a coal export terminal, and an estimated 1.6 billion MT of untapped reserves spread across three major American coal basins. Coal sales comprise the overwhelming majority of the business, but the company has also worked to increase revenue generated from freight and terminal throughput to more fully leverage its Appalachian asset base.

While freight and terminal sales combined to represent just 9.5% of overall revenue in 2017, that was up from a 6.3% share in 2016. It was made possible by record throughput of 14.3 million MT at its export terminal, an increase of 77% from the prior year. That wasn't the only part of the business cooking for the coal miner last year. 

CONSOL Energy turned in record coal production of 26.1 million metric tons in 2017 from the three mines comprising the PAMC. When combined with higher selling prices than the year before, it's easy to see how the company turned in a solid year-over-year performance. 

Data source: SEC filing.

1. Last year was pretty good to CONSOL Energy, thanks in large part to a stabilizing coal market in the United States and increased appetite for American coal overseas. In 2015 and 2016, the company's coal exports averaged 5.5 million MT per year, or about 23% of sales volumes. In 2017, that jumped to 8.3 million MT, representing 32% of sales volumes.

The good news is management expects the relatively good times to continue in 2018: Coal production is expected to set another annual record with 27 million MT.

The bad news is there's no denying that the American coal industry is a shell of its former self. Annual net income of $68 million in 2017 is a far cry from the $300 million levels the business averaged from 2013 to 2015. Unfortunately, the obstacles facing coal producers aren't limited to the American market, despite a recent uptick in exports. 

Image source: Getty Images.

Can coal maintain its momentum?

The Appalachian coal leader runs a profitable business that is adapting to industry trends, namely increased exports from the United States and healthy demand for metallurgical coal (the kind used for industrial processes, not electricity generation). But there's no denying that coal-fired power plants and industrial processes are increasingly being replaced by other, cleaner sources of power.

For example, changing market dynamics in the American power sector continue to disproportionately affect coal-fired power plants. The United States is set to retire an astounding 13 gigawatts of coal-fired capacity in 2018 alone -- the second-highest annual total of the last decade. 

Considering coal producers are being largely carried by exports right now, there are more worrisome risks brewing internationally. The overnight emergence of a robust global market for liquefied natural gas (LNG) poses a significant risk to coal's future, especially considering the two countries growing LNG imports the fastest are China and India, the world's two largest consumers of coal. It's no secret they're racing to substitute natural gas for coal in both industry and power generation. In fact, industrial processes were responsible for over half of China's year-over-year increase in natural gas demand. 

Domestic and international factors don't bode well for the long-term future of coal, even if the next several years provide a glimmer of (likely false) hope. Neither do the current valuation metrics compared to peers. While CONSOL Energy stock has nearly doubled the gains of Arch Coal and Peabody Energy since relisting in late 2017, it now trades roughly in line with its larger competitors on several metrics. In fact, it trades at a premium on certain metrics.   

Data source: Yahoo! Finance.

Unless Mr. Market finds unique value differentiators in the business of CONSOL Energy compared to its peers, and still thinks those aren't properly accounted for after the 50% run-up since relisting, shares should not continue to outpace Arch Coal or Peabody in the near future.

Do you want to own a coal stock?

The fact that CONSOL Energy owns a major export terminal should allow it to piggyback on growing international shipments relatively easily, which will be a boon in the near term. However, it's important to remember that coal production and sales will continue to make or break the business, and that international demand for American coal is being pressured by (mostly American) LNG. Therefore, even though this coal producer is profitable and generally healthy, I would encourage forward-thinking investors to not own a coal stock in their portfolios.