The dismal forecast on the outlook of the coal industry issued by Joy Global (NYSE:JOY) last week alongside the company's fiscal second quarter earnings did not make for pleasant reading.
Joy is considered somewhat of an authority on the coal market as the company manufactures equipment for coal mining. As a result, the company is a proxy for the market, being a leading indicator for mine activity.
The first thing that Joy noted was that seaborne thermal coal markets remain challenged as supply of the mineral outpaces demand. Unfortunately, this problem is only likely to get worse as new legislation that was announced by the U.S. Environmental Protection Agency last week comes into force.
This new legislation could be, in a word, disastrous for the U.S. coal industry. The rules will make it virtually impossible to build new coal power plants within the U.S. without carbon capture and sequestration technology. With this being the case, it is estimated that around 15% of existing U.S. coal burning capacity is due to be shut down by 2016.
Around 90% of coal produced within the U.S. is used for electricity generation, so even a small reduction in demand will have a significant impact on prices. A slump in demand of 15% is likely to push prices significantly lower. It's obvious that this will be bad news for domestic coal miners but it will be even worse for Joy.
Bad news for Joy
Thermal coal prices have been declining steadily since their pre-financial crisis peak of $190 per ton, averaging $75 per ton during May. Some analysts see the price falling as low as $60 per ton by the end of next year, and this is putting pressure on the whole industry. As prices continue to fall, pushed lower by falling demand from the U.S., coal producers around the world are likely to go under. Many of these will be Joy's customers.
Prices too low
Actually, many U.S. producers are already hemorrhaging cash. Further price declines within the coal market are only going to make matters much, much worse.
Arch Coal (NASDAQOTH:ACIIQ) for example reported an average cash sales margin of 8% per ton of coal sold during the first quarter of this year. The company's operating cost per ton was 8% higher than its sales cost, so the company was losing $1.61 per ton sold. A further deterioration in coal pricing will only lead to wider losses, which is something that Arch can ill afford.
The company burned through $45 million during the first quarter, leaving $870 million in cash. The company reported a net debt-to-EBITDA ratio of just under 143 times for the quarter, while the ratio was 48 times at the end of full-year 2013.
On the other hand, Peabody (NYSE:BTU) is reporting a much stronger margin from its U.S. operations. The company's average cash margin per ton mined within the U.S. is closer to 26%, more than three times more than that reported by Arch. However, the company's Australian operations are where the troubles have started.
Peabody reported a cash margin of 0.3% for its Australian production for the first quarter. The company's outlook also revealed that Australian cash costs were expected to be kept within the low-mid $70 per ton range. If prices drop to the $60 per ton level as mentioned above, this could drag the company down.
All of this is bad news for Joy. As a producer of coal mining equipment, Joy relies on the capital spending budgets of companies like Peabody and Arch. If these companies are losing money and the price of coal is falling, they have little incentive to spend on new mining equipment.
Overall, it would appear that the price of thermal coal is in freefall. This will only get worse if the new EPA regulations come into force. Arch Coal is already suffering from the falling price of coal, and so is Peabody, albeit to a lesser extent. Joy Global is likely to struggle going forward.
Rupert Hargreaves has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.