Coal has an image problem. It's under political and regulatory assault for being a "dirty" form of energy as well as being an unsafe industry. The Massey Energy mining disaster a couple of years ago that crippled the company and led to it being sold to Alpha Natural Resources
Because of regulatory actions as well as competitive reasons (and sometimes the two are inextricably linked), coal has gone from producing 50% of this country's energy to less than a third. Alpha says the central Appalachian region went from producing 300 million tons of coal annually at its peak in 1997 to 160 million tons today. According to the Energy Information Administration domestic coal output in 2012 will fall 7.4%, or by 81 million tons.
The switch to metallurgical coal -- the kind that is used to produced steel -- that was supposed to prop up miners like Alpha, Peabody Energy
Analysts don't expect pricing to rebound next year and predict that if metallurgical coal stays below $200 a ton and thermal coal doesn't find some catalyst to drive it much higher, coal miners like Peabody and Walter Energy will turn cash flow negative. A Bloomberg analysis says Alpha, Peabody, and Arch were already cash flow negative in the second quarter of 2012, though only Peabody was able to generate any free cash flow over the first half of the year.
Cliffs Natural Resources
Some analysts are putting great faith in the new round of stimulus spending by the Federal Reserve to pull coal away from the brink. Coupled with China's intention to spend $150 billion on infrastructure improvements, the hope is that it will prop up pricing.
Unfortunately, I think it's a temporary salve. The president of the Fed's Philadelphia bank said the other day that Ben Bernanke's new round of quantitative easing will have a negligible impact on interest rates, the economy, or employment. China's new spending program seems only to confirm that its own prior massive stimulus wasn't successful at expanding the economy so there's little reason to think new spending will be generated. The country's purchasing manager's index was below 50% yet again, indicating that the economy is still contracting.
I believe the lack of confidence in the ability of government to spend our way out of this morass is priced into valuations that coal miners currently sport. You'll find most trading at less than 10 times earnings, but analysts think Cliffs might have a unique opportunity as it begins production of a premium grade ore from its Canadian mine at Bloom Lake, which ought to attract new customers while providing higher margins.
Others have taken a different tact altogether, actually embracing their "enemy." Consol Energy bought gas-producing assets from Dominion Resources in the Marcellus shale region two years ago while met-coal producer Natural Resource Partners
Scarcity of opportunity
Despite the risks, I continue to like the better prospects for Cliffs. Asian markets beyond China are still recording strong demand, and with its focus on Asia I think it comes out better than most players in the space. Global iron ore sales volumes jumped 13% last quarter even though lower pricing pushed revenues down. The stock is down 49% from its highs, but it's up 20% from the lows it hit just last month.
There's little doubt that both the coal and steel industries are difficult plays right now, but I see Cliffs geographic diversity cushioning the blow and putting it ahead of its peers, while its dividend yield of 6.5% seems sustainable. The overall industry, though, seems headed for worse times; it will be up to investors to pick and choose their entries, but let me know in the comments box below if you disagree that Cliffs Natural Resources can dig its way out of the hole.
Ready for a rubber match
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Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Dominion Resources and Walter Energy. 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. Try any of our Foolish newsletter services free for 30 days.