Fundamentals in the coal sector have been challenged for the past few years. Global oversupply of thermal coal, used for electricity generation, has kept a lid on coal prices. Only slowly is the higher-cost coal supply being curtailed. However, in some cases, newer supplies of lower cost coal are replacing it.
On the coking coal side, the coal used in steel making, supply from Australia has been rising for three straight years. Flooding in Queensland, Australia, which was a major disruption to supply in two of the past six years, did not occur this year or last. In addition, multiple rail and port infrastructure improvements have come to fruition. This has culminated in the just-announced quarterly coking coal settlement of $120 per metric tonne, the lowest in six years.
Not even in the depths of the financial crisis of 2009 was coking coal settled at a price that low. Back then, the price was $129/tonne. Since 2009, the costs of mining both coking coal and thermal coal have risen dramatically. Therefore, operating margins, especially unit margins, have tumbled. Globally, no coal producer has been able to thrive in this depressed market. Even a recent spike in natural gas prices due to a very cold U.S. winter failed to meaningfully move coal prices.
U.S. coal producers in a world of pain, debt weighing heavily
Walter Energy (WLTGQ) just issued new high-yielding bonds to help it live through the depressed coal market of 2014. Multiple analysts have cut price targets and lowered ratings on Walter, Alpha Natural Resources (NYSE: ANR), Arch Coal (NYSE: ACI), and Peabody Energy (BTU). Consol Energy (CNX -0.63%) has been less affected by analyst cuts because it has a substantial natural gas business and a more manageable balance sheet.
Debt, a large chunk taken on in 2011, is a major problem for Walter, Alpha, Arch, and Peabody. All four made acquisitions at the top of the market that year and are now fighting for survival. Alpha acquired East Coast player Massey Energy. Massey had a lot more operating problems than Alpha bargained for. Walter acquired a Canadian asset, Western Coal. That operation had high costs, which although they have come down, are still too high (Walter's Canadian operations are idled). Arch bought International Coal, a company just beginning the capital intensive construction of a new mine. Peabody bought an Australian company, MacArthur Coal. MacArthur's niche product, "PCI" coal, fell out of favor within a year of that deal.
Coal stocks on sale, time to buy?
These stocks are down 85%-95% from 2011 highs, begging the question of whether now is a good time to buy them. The blood is certainly flowing. The sector is despised. I've written extensively about coal stocks since 2011 and have been both right and wrong on calling turning points. This time around I note that while all of the pieces are in place for a bottom, I see no near-term catalyst for a rebound. That sounds like an ambiguous call, so let me explain.
This week's surprisingly weak coking coal settlement suggests that there's no rush to get invested. 2014 is going to be a terrible, terrible year and there's no evidence that 2015 will be strong enough to save the debt-laden coal companies. To be clear, these companies are not going bankrupt this year -- they've spent the last two years preparing for lean times. Cash burn has been slashed, but with the benchmark coking coal price at $120/tonne, no U.S. player can make money.
Final thoughts
Now is not the time to buy U.S. coal producers in any meaningful way. The next few months should be a period in which prospective investors get to know the companies -- read earnings call transcripts and importantly the annual 10-k filings coming out as we speak. Even investors who own coal stocks or have owned them in the past need to take a fresh look. A lot has changed. Not only has debt become a crushing weight, but operating footprints and growth plans are different. Doing some due diligence could lead to some smart buying opportunities later this year.
