6 Investment Opportunities in Thermal Coal

Monday, May9, 2011

After the Japanese nuclear disaster, many countries have imposed new nuclear power plant moratoriums. This list even includes China, for the near term. Emerging markets growth means more need for electrical power. Many countries will use thermal coal power plants to provide this electrical power. This means more thermal coal use. China’s GDP for Q1 was near 10%, and India’s was 8%. As a whole, the World Bank estimates the world GDP will rise by 3.3% in 2011, and 50% of the electricity generated worldwide is from coal plants. China accounted for 70+% of the growth in the coal consumption recently. Most expect this general trend to continue. If China’s GDP is still growing at approximately 10%, the demand for coal is growing rapidly. In addition, there has been damage to the coal infrastructure with the storms/flooding in Queensland Australia. Japan is expected to replace its lost nuclear generated electricity (approx. 10% of total Japanese electrical capacity) with mostly coal-generated electricity. The growth in coal consumption is an unassailable fact for the near term.

Taking a brief technical look at the markets, one can see that coal stocks, as represented by the proxy of the KOL ETF (KOL), are at oversold levels in the short term.

The 1 year chart of KOL:

　

Both the Williams %R indicator and the Fast Stochastic indicator show KOL as oversold. Neither one indicates that coal cannot become more oversold. In fact, if oil continues to sell off, it seems likely coal will follow along with it. The 2011 oil price target increase by JPM on Sat. May 7^th may tend to push oil up instead. Currently oil is near $98. There is good support at $95. It hit $94.63 early Friday morning. The bounce off support there could continue if we get good economic news. Plus with Mutual Fund Monday, coal should follow oil.

Longer term, where coal goes may depend on tightening actions in China and India. It may depend on the state of the credit crisis in the EU. There seems to be a growing chance of a Greek default/haircut within the next few months.

More immediately, the recent good non-farm payrolls data may lift commodities such as oil and coal. However, the rally in the USD may tend to counteract this. The rally was started by Trichet‘s indication that there would be no ECB rate raise at the June ECB meeting. If the USD rally continues near term, it will tend to push commodities downward. Bad economic news will tend to push commodities downward. A continued USD rally will also tend to push the overall market downward, as it will likely cause at least a partial unwinding of the USD carry trade. Still, with the good non-farm Payrolls data Friday, the JPM oil price outlook raise, and the oversold conditions of coal equities, this might be a good time to start to average into your coal stock(s) position(s). At worst, you could trade short-term.

Longer term, the overall growth of thermal coal seems inevitable for the next 5+ years. The idea that fast growing, emerging market countries will use an increasing amount of thermal coal for an increasing amount of electricity generation is a solid one. The expected increase in the price of oil over that time should only help coal prices rise. With that in mind, the table below contains some of the fundamental data for several prominent thermal coal companies. The data in the table is from Yahoo Finance and TDameritrade.

Irish PM Enda Kenny is strongly hinting that Ireland will give debt holders a haircut and at least some of its banks. Portugal has tentatively agreed to an EU/IMF bailout. However, it has no government until the early June elections. The last government was dissolved because it would not approve an austerity package, which was a necessary prerequisite to a bailout. The Finns, with significant opposition from the True Finns, may not be able to get approval for the Portugal bailout through their Parliament. They must legally do this before Finland can agree to the bailout. Given the current uncertainty about Greek repayment, the Portugal bailout is uncertain at best. In sum, the EU credit crisis could easily escalate to a post Lehman Brothers-like “credit seize up” at almost any time. Any prudent investor will be watching this situation carefully. Still, the markets do like to "climb a wall of worry".

Stock	James River Coal (JRCC)	Cloud Peak Energy (CLD)	Consol Energy (CNX)	BHP Billiton (BHP)	Vale S.A. (VALE)
Price	$22.82	$19.95	$49.13	$95.50	$31.02
Analysts’ 1 year target price	$28.92	$25.50	$61.75	$113.47	$43.36
PE	15.01	20.36	25.48	15.58	8.82
FPE	7.36	9.55	11.04	12.34	6.13
Analysts’ Average Recommendation	2.3	2.4	2.0	2.5	2.0
Beta	1.56	--	1.37	1.43	1.49
Price/Book	2.56	2.17	3.56	4.72	2.35
Price/Cash Flow	5.51	5.69	10.7	10.6	7.93
Cash/share	$0.22	$6.49	$0.56	$9.76	$2.93
Short Interest as a % of the Float	39.20%	8.60%	2.40%	0.48%	0.67%
5 year EPS Growth Estimate per Annum	-21.00%	0.60%	10.00%	14.75%	3.80%
Market Cap	$785.67M	$1.20B	$11.13B	$265.63B	$161.87B
Enterprise Value	$687.19M	$1.57B	$14.63B	$264.99B	$180.19B
Total Debt/Total Capital (mrq)	53.45%	56.02%	53.76%	21.87%	26.30%
Quick Ratio (mrq)	2.58	2.0	0.58	1.8	1.53
Interest Coverage (mrq)	1.39	4.46	4.78	142.3	25.15
Return on Equity (ttm)	36.31%	11.83%	12.79%	34.21%	27.46%
EPS Growth (mrq)	905.63%	17.43%	54.39%	71.71%	294.57%
EPS Growth (ttm)	52.18%	-60.63%	-20.63%	82.30%	224.99%
Revenue Growth (mrq)	8.42%	14.65%	18.17%	39.02%	135.73%
Revenue Growth (ttm)	2.87%	5.01%	17.62%	38.62%	94.30%
Annual Dividend Rate	--	--	$0.40	$1.82	$0.7585
Operating Profit Margin (ttm)	11.96%	15.39%	10.56%	40.75%	47.90%
Net Profit Margin (ttm)	11.15%	7.93%	8.11%	28.03%	36.67%

From this table, BHP and VALE both look like solid companies with good growth prospects. You would probably be well off to invest in either. However, they are far from pure thermal coal plays. They are huge general miners. They mine iron ore, copper, gold, bauxite, etc. in addition to thermal coal. Still they are great miners, and one wouldn’t go too far wrong investing in either one. BHP would seem to have the better growth prospects of the two. It is the most likely to give good price performance. It also has substantial resources near China (Australia), while VALE is headquartered in Rio de Janeiro. Since China is a big coal importer, BHP’s location of substantial resources near China gives it a huge advantage over VALE.

Of the other 3 companies, Consol looks to be the most solid, with a 5 Year Growth Estimate per Annum of 10.00%. It also has very little short interest, which is a sign that most investors believe it is a strong stock. Of course, this means it cannot be manipulated upward (or downward) as quickly. It may give slower price performance movement compared to the other two more highly shorted thermal coal stocks.

In contrast, James River Coal has short interest as a percentage of the float of 39.20% (Yahoo Finance). It could move up quickly on earnings, which are on May 10, 2011. If it beats (and guides higher), JRCC’s stock price seems likely to rise rapidly. One might consider making a small bet on this over earnings. Monday is Mutual Fund Monday. That only leaves Tuesday to worry about. It has been my experience that a “too high” short interest almost ensures a short squeeze if earnings are at all palatable. You can get a May call $23/$26 call spread for only about $0.70.

For the long term, BHP, VALE, and CNX offer some strength in fundamentals with a goodly amount of growth. The prospects of JRCC and Cloud Peak are enticing,. However, these latter two may be stocks that prevent you from sleeping well. The former three are unlikely to cause nearly as much anxiety. Since I like to sleep at night, I would recommend you choose one or more of BHP, VALE and CNX. Since CNX is the only pure thermal coal play in the bunch, it may be a wise choice for an investment aimed at thermal coal.

The 1 year chart of KOL (as a proxy for coal stocks) appears above. Both the Fast Stochastic and the Williams %R indicators indicate an oversold condition exists for KOL. The individual coal stock charts indicate much the same thing. There is a good chance that coal is about to rally. This means that you can start to average into your position with some confidence of a good near term result.

(sourced : Seeking Alpha)