At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about.
Nomura: No big fan of coal stocks
As trading wound down for the week on Friday, Tokyo trading titan Nomura Securities found time to sneak out a final handful of stock recommendations. Initiating coverage of the U.S. coal mining industry, Nomura warned investors to avoid coalminers in general, and two stocks in particular.
According to Nomura, America's miners depend largely on China to fuel demand for their raw materials. Problem is, there's a supply glut brewing in coking coal over in China. Additionally, on the domestic front, Nomura warns that low natural gas prices are catalyzing a shift from coal to gas among American energy utilities: "Coal to gas switching could eliminate upwards of 50 million tons of coal demand in the U.S. during 2012." As a result, gas demand should tick up this year, but coal demand is headed into the dumps.
Coal for Christmas
Nomura sees these trends punishing Arch Coal and Patriot Coal particularly hard. The analyst warns that Arch faces "very significant price compression for its lower quality coking coal mix." Similarly, Patriot is encountering "cost inflation pressure ... coupled with significant price pressure in the lower quality met coal spectrum." Consequently, Nomura says both stocks will miss consensus earnings targets over the next couple years, and calls Arch and Patriot "high-conviction short ideas."
Nomura's less pessimistic on the prospects for Alpha Natural
The best bet in coal?
Really, out of the entire coal industry, the only stock Nomura sees any hope for is Consol Energy
Is Nomura right? Is Consol the one coal mining stock that will ride out the industry's problems?
Perhaps. But I wouldn't bet on it. Priced at 12 times earnings, Consol's not the cheapest stock of the lot. Walter, Peabody, and Teck all sell for lower P/E ratios. Consol's not the fastest grower, either. At 24% projected earnings growth, Nomura-sell-rated Arch Coal is actually speedier. And with $2.8 billion in net debt on its books, Consol doesn't even boast the best balance sheet in the industry. It's really just middle-of-the road.
A better idea
Actually, I think the best bet of the stocks Nomura initiated coverage on last week is not Consol Energy, but rather Teck Resources -- a stock that Nomura is only "neutral" on.
Why? For one thing, Teck's got more heft to it. Valued at $22.8 billion, it's the biggest company of all those discussed so far, and by a wide margin. It's also the most diversified. While Teck Resources gets the majority of its revenue from coal mining, it also has substantial copper and zinc mining operations. Indeed, combined, these two units bring in more revenue for Teck than does coal.
And yet, at eight times earnings, Teck Resources remains the cheapest of the coal mining stocks -- and the only one that boasts both positive net income and free cash flow superior to its reported net income. And a look at its balance sheet reveals Teck's $2.7 billion in annual free cash flow is sufficient to pay off the firm's entire $2.7 billion net debt in the space of a single year.
Foolish final thought
Teck Resources isn't a stock I'd ordinarily consider investing in myself. For all its positives, the firm ranks dead last in projected earnings growth among coal-mining stocks, with analysts predicting long-term earnings growth of just 2.6% annualized. Then again, analysts have been wrong about Teck before; it's exceeded analyst estimates in two of the past four quarters.
If you're looking for coal prices to rebound, and looking for a coal stock to ride that rebound, I'd look at Teck Resources before any of the others.
Click here to add Teck Resources to your Fool Watchlist.
But what if you think coal prices will keep falling, and that natural gas is the wave of the future? In that case, you'd be well advised to read the Fool's new -- and free -- report: " The One Stock You Need to Own for the Coming 'No Choice' Energy Revolution ."
Motley Fool newsletter services have recommended buying shares of Walter Energy. Fool contributor Rich Smith holds no position in any company mentioned. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 397 out of more than 180,000 members. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.