Metallurgical coal is used in the steel making process and although prices are weak today, demand is set to increase over the long term. That should be a boon to BHP Billiton (NYSE: BHP),Peabody Energy (BTU +0.00%), and struggling Alpha Natural Resources (NYSE: ANR).
Demand for steel
Iron ore and coal miner BHP Billiton is projecting steel demand to continue increasing through 2030 because of the population shift in emerging economies from rural areas to cities. That's been a big theme in China, where steel production increased at an annual rate of about 15% during the first decade of this century. That said, BHP is looking for China's production growth to moderate to an annual rate of a little under 3% through 2030.
That's reasonable as the country has started to mature. In fact the slowing economy in China has already led to a notable drop in steel prices since supply has gotten ahead of demand. However, the rest of the world is expected to pick up some of that slack, with the average growth rate in demand increasing from under 1% between 2000 and 2010 to just over 3% through 2030. While the heady days of steel appear to be behind us, slow but steady growth looks to be ahead.
That won't lead to massive price increases for iron ore or met coal companies, but once supply and demand balance out, it should lead to improving business fundamentals. BHP, which also pulls oil, natural gas, copper, among other things out of the ground, is well positioned to benefit from a long-term increase in steel demand since it's a world leader in both iron ore and met coal. Moreover, it has a globally diversified business, so it can sell into just about any market.
The company just reported particularly weak results for fiscal 2013, however, because commodity prices have been generally weak. That said, despite revenues being down nearly 9% and profits down nearly 30%, the company still posted earnings of over $2 a share. And that's in a bad market environment.
With a renewed focus on reducing costs and a token dividend increase, BHP might be of interest to investors looking for a diversified miner. And with a dividend yield around 3.6%, it will pay investors to wait for a turnaround.
More coal, but less risk?
For those seeking a more focused play, Peabody Energy might be a good alternative. Although the company only mines for coal, it has a global footprint via its large Australian operations. Australia, which accounts for about 50% of the company's top line, sells met coal and thermal coal into Asia, benefiting from the country's close proximity to the region.
Although lower coal prices forced BHP to write down the value of some of its Australian assets, it was a relatively small portion, around 10%, of its investment in the region over the past decade. One of the world's largest met coal providers, Peabody is financially strong and should have no problem surviving the current industry rationalization.
Assuming steel demand hits the slow but steady stride that BHP projects, Peabody will be ready to go for the ride. Still, 2013 is going to be a bad year for Peabody on the earnings front. It is projecting anywhere from a loss of $0.16 a share to a profit of $0.09 in the third quarter. The fourth quarter should be just as uncertain. Longer-term investors looking for a relatively safe play on a coal market rebound, however, should take a look.
Down, but not out—yet
For really aggressive investors, struggling Alpha Natural Resources might be the best option. The company has lost money in eight of the last ten quarters and its shares are down some 90% over the past five years. This is a situation that isn't likely to change until coal prices start to pick up.
That said, Alpha Natural Resources was the third largest global provider of met coal in 2012. And it has more terminal capacity than any other other U.S. coal miner, putting it in good position to continue supplying the world's coal needs. Almost half of Alpha Natural Resources' sales come from its met operations.
The company's debt level, at about 45% of the capital structure, is reasonable, but the first half was particularly weak, with negative free cash flow. That's the first time since the company went public that it's burned cash. That's a bad sign and makes the stock much riskier than BHP or Peabody, but also provides notable upside if it muddles through to brighter days.
Not all bad
Iron ore and met coal are near necessities as emerging economies industrialize. You can't build infrastructure without them. Although the heady growth days are behind this dynamic duo, slow and steady demand growth is what lies ahead. Once the current market stabilizes, BHP and Peabody will both benefit from better pricing and higher demand. Alpha Natural Resources will, too, but getting to that point is likely to be trying for investors as it will be filled with red ink. The upside potential, though, is likely to be higher.
