Are You Buying the Coal Dip?
Don’t — at least, not if the analysts at Goldman Sachs are right.
“We view coal stocks’ recent rebound as pre-trading a cyclical recovery in 2013 that we believe will be temporary,” analysts said, according to Street Insider. “Stocks could trade higher but our Netural coverage view reflects our concerns for a group at risk of going off a ‘recovery cliff.’”
The firm downgraded their rating on the sector to “Neutral” from “Attractive,” seeing only 2 percent upside on average. An expected 11-percent increase in thermal coal demand and a recovery of metallurgical prices to $200/MT “appear priced in” at the current value.
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The debate surrounding the future of the coal industry raged as the U.S. presidential election heated up. Whether or not the perception was grounded in reality, the possibility of a Republican in the White House fueled a speculative surge in coal stock prices leading up to the election. Many in the industry feel that the Obama administration has fostered an oppressive regulatory environment for coal producers and support from Washington would be a welcome break.
Regardless of politics, the coal industry faces substantial market problems. The Goldman analysts point at four major, short-term issues facing the U.S. coal industry: declining thermal coal demand as plants retire heading into 2015, export competition from Australia and China, the still-depressed global economy burdening already over-taxed balance sheets, and the blunt reality of diminishing and more difficult to access reserves.
Triggered by its recent earnings report but highlighting the damages that can result from speculative price increases like those seen before the election, James River Coal Company (NASDAQ:JRCC) has been absolutely slaughtered in the market the past few days. The company’s shares have lost over 37 percent of their value in the last five trading days, after gaining over 61 percent from the beginning of October through election day.
Coming out of the presidential election, it’s increasingly clear that regulation is playing a backseat roll in the coal industry compared to market factors and investors should be looking at competition and company fundamentals ahead of policy. The Goldman analysts point at SunCoke Energy (NYSE:SXC) and CONSOL Energy (NYSE:CNX) as industry members that may come out ahead of their peers because of their potential for organic growth and strong balance sheets. CONSOL Energy, for its part, is diversified into natural gas, which serves as a pretty effective hedge.
Arch Coal (NYSE:ACI) was called out as a loser by the Goldman analysts. Despite posting strong third-quarter earnings, the company clearly warned investors to stay away with negative return on equity and unreliable earnings.
Alpha Natural Resources (NYSE:ANR) squeaked through the Goldman analysis with a neutral rating. The company had some brutal quarters in 2011, and while 2012 looks positive with $7 billion in revenue and EPS of $1.57 expected, analyst consensus puts 2013 at an EPS loss of $1.35 while revenue drops 17.5 percent to $5.78 billion. Still, if there’s room to grow in the coal industry, ANR will be one of the companies that does it.
At the end of the day, the coal industry looks bruised and battered. Whether its competition from natural gas, the regulatory environment, or the macro-economic condition, the analysts at Goldman appear to be on to something.