What: Shares of Peabody Energy (NYSE:BTU), a producer of both metallurgical and thermal coal, nosedived 35% in June, based on data from S&P Capital IQ, after a number of concerns surrounding the coal industry, and Peabody, came to a head.
So what: For starters, both thermal and metallurgical coal prices have been weak. Falling coal prices would normally be expected to improve demand from electric utilities, but low natural gas prices as well are encouraging utilities in greater numbers to make the switch from coal-fired plants to cleaner-burning natural gas. As coal supplies build and prices continue to drop, the situation just keeps getting worse.
Another major problem for coal producers were questions raised regarding their possible liability to cover environmental damage. As noted by Bloomberg, the Wyoming Department of Environmental Quaity's Land Quality Division is reviewing Peabody to determine if it'll need to boost its cash position or buy Treasury bonds in order to cover possible reclamation claims. The prospect of Peabody needing to raise cash with its stock in freefall and the company carrying $6.4 billion in debt is worrisome.
Adding to concerns, Peabody announced in early June that it was cutting 250 corporate and regional jobs. While these layoffs represent only 3% of Peabody's total workforce, and any job cuts should result in cost savings, the idea of job cuts serves as another reminder of the cost pressures Peabody is currently under.
Lastly, at the end of June Peabody Energy provided an update on its second-quarter that included a $40 million weather-related impact due to flash flooding in the Southern Powder River Basin, and an expected $20 million reduction from lower metallurgical coal pricing in Australia. Long story short, Peabody's results are going to miss the mark.
Now what: I believe "Yuck!" aptly summarizes the cumulative opinion of coal stocks at the moment. Yet, in spite of the distaste for coal stocks, I don't believe all hope is lost.
For instance, according to the U.S. Energy Information Administration's statistics, coal was responsible for nearly 39% of net electric generation in the U.S. in 2014. This is down from nearly 50% in 2005, so we're seeing an undeniable shift toward cleaner and renewable energies. However, 39% of net electric generation isn't going to disappear overnight, making the precipitous swoon in coal stocks a possible buying opportunity.
But, on the flipside you'll want to keep in mind that coal stocks are only appropriate for the riskiest of investors here. There's a pretty good chance that bankruptcies and/or consolidation is the only way we're going to see a longer-term solution to the current supply glut. Additionally, concerns over China's economy and its recently plunging stock market raise concerns over the demand for metallurgical coal.
We're probably not anywhere close to seeing the end of the volatility in the coal sector, so for the time being I'm sticking squarely on the sidelines.
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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