The market indexes have performed incredibly well this year despite a steady stream of "the world is ending" news from Europe and slowing growth in China. As of this past weekend, the broad-market S&P 500 had advanced nearly 14%; but it hasn't been fun and games for everyone. There are more than a handful of sectors vastly underperforming the overall market this year.
Mirrored after the two bold calls I made to begin the year, I'm jumping the gun and making three additional calls over three days in three downtrodden sectors that I expect to greatly outperform the S&P 500 in 2013. These probably aren't the most popular sectors, but big banks have had an incredibly strong year and they weren't exactly a prime selection to rebound when the year began. That selection of mine, however, has turned out quite prescient.
Yesterday, I made my first bold call by predicting that trucking companies would drive over the pessimists in 2013. Today, as part two of this three-part series, I plan to highlight a sector that has been smudged into purported irrelevance within the past year: coal companies.
Why the sector dug itself a hole in 2012?
Coal companies generally come in two forms: thermal coal and metallurgical coal, or met-coal. Thermal coal is the type electric utilities use to make electricity while met-coal is used to strengthen steel. Both types of coal are unique, but they both require the global economy to remain strong to drive demand.
Coal companies haven't quite had that luck. Demand for coal products in all forms has waned significantly in the U.S. as natural gas prices fell to record lows, prompting electric utilities to shutter or transform coal-burning plants into natural-gas-burning facilities. With coal prices collapsing and stockpiles rising, coal companies couldn't do much other than cut production and temporarily close mines. Arch Coal (NASDAQOTH:ACIIQ), CONSOL Energy (NYSE:CNX) and Alpha Natural Resources (NASDAQOTH:ANRZQ) have all trimmed production and/or closed mines recently in order to cut expenses and output.
What's going to change in 2013
With countless subsidies available that are pushing consumers and businesses toward clean energy alternatives, you're probably curious as to why coal stocks should be on your radar in 2013. I can think of at least three key reasons.
For starters, coal is still engrained as a primary energy source in the United States. Even after low natural gas prices coerced quite a few utilities to switch to natural gas, coal was still ultimately responsible for 42% of all electrical generation in 2011 according to the U.S. Energy Information Administration. Coal isn't going to disappear overnight, yet these stocks are being priced as if such an occurrence is happening.Â
Second, note the strength in international demand for coal. Both China and India are in the midst of rapid industrialization, which requires a lot of steel (met-coal) and plenty of electrical-generating capacity. While the health impacts of coal on the environment aren't completely ignored in foreign countries, few take them as seriously as the United States. That means there are far fewer restrictions in place for coal overseas. It's also worth noting that China enacted a $156 billion infrastructure plan last month to jump-start its GDP growth back to its historical average of 10%. That's great news for met-coal producers, as this project should be steel-intensive.
My final point goes back to an argument I made in April that the difference in price between coal and natural gas was a simple case of push-pull economics that would eventually correct itself. Unsurprisingly, natural gas prices have already jumped more than 75% off their lows and electric utilities are finding less cost benefit from paying out millions to convert their plants from burning coal to natural gas. Coal remains consistently cheaper than nuclear energy and more feasible and abundant than alternative energies that are currently available.
My top pick: Alliance Resource Partners (NASDAQ:ARLP)
I was very tempted to go with Arch Coal here thanks to recently signed deals that could boost its international exports fourfold by 2020, but the safer bet appears to be Alliance Resource Partners. Set up as a master limited partnership, Alliance Resource receives favorable tax status relative to its peers which allows it to pay out more of what it earns in the form of a dividend. As I recently highlighted, the company has increased its dividend in 17 straight quarters and has delivered 15.5% average annual dividend growth over the past decade. Let me not forget that it's also delivered 11 consecutive years of record profits, thanks to securing long-term contracts for its coal.
The company I'd avoid: James River Coal (NASDAQOTH:JRCCQ)
Usually there's a bad apple in every bunch, and James River looks like it'll be the odd company out of the group. Rising natural gas prices and new infrastructure plans from China should begin moving the needle back in coal companies' favor; however, profits could still be a few quarters away. For many coal producers that won't be an issue, as they're well-capitalized. This isn't the case for James River Coal, whose debt has ballooned from $168 million to $590 million since 2008. Although the company's debt doesn't come due until 2015 at the earliest, the bankruptcy of Patriot Coal serves as a stark reminder that poorly capitalized companies are a gamble in any form.
In the past two days you've now seen two of the three sectors that I feel are ready to rebound in a big way next year. Come back tomorrow and I'll reveal the third and final sector that I expect to soar higher in 2013.
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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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