Will Coal Make a Comeback in 2014?

The U.S coal industry has slowed down in 2013. Despite this slowdown, several coal companies including CONSOL Energy (NYSE:CNX) and Alliance Resource Partners (NASDAQ:ARLP) were able to increase their sales, while other coal companies such as Peabody Energy (NYSE:BTU) didn’t perform well. Will the coal industry heat up in 2014? Will coal companies improve their performance? Let’s examine these issues.

2014 outlook

During 2013 the coal industry contracted: Based on an Energy Information Administration report, coal production declined by 1.5% during the 2013 year over year. Despite the moderate drop in production during last year, the EIA estimates the coal production will increase by 3.6% in 2014. The rise in production is mainly because of an expected increase in consumption and stable inventories. Moreover, the International Energy Agency projects the coal industry will rise, on average, by an annual rate of 2.3% through 2018. These factors suggest that coal companies could show an increase in sales in 2014. Let’s consider how leading coal companies plan to perform in 2014.

Coal companies’ outlook for 2014

During the first nine months of 2013, the coal producer Alliance Resource Partners has increased its production by 15% year over year. In 2014, the company expects an increase in production mainly due a rise in production at its Tunnel Ridge mine; several mines are expected to start producing later this year including Gibson South mine and White Oak mine.

Peabody Energy hasn’t increased its coal sales (in tons) during 2013. The current outlook is that the company’s total sales reach between 245 and 255 million tons. Back in 2012 , the total amount of coal sold was 248.5 million tons. During the first three quarters of 2013, the company’s revenue fell mostly due to the sharp drop in coal prices in Australia. For 2014, the potential rally in the U.S coal industry might translate to higher sales in the U.S, which account for 57% of Peabody Energy’s total revenue.

Despite the expected recovery of the coal industry not only coal companies are putting their faith in coal: CONSOL Energy has decided to sell its five West Virginia Longwall coal mines to Murray Energy. This transaction will free up nearly $2.4 of CONSOL Energy’s liabilities. Thus, in 2014, the company’s coal sales are expected to plummet by 48% year over year.

Due to this deal, CONSOL Energy will receive $850 million in cash along with $184 million in future payments. This sale will enable CONSOL Energy to increase its capital expenditure towards its natural gas operations. The company plans to allocate nearly $1.1 billion of its total $1.5 billion capital expenditure in 2014 towards natural gas operations; its goal is to increase its natural gas production by 30% during the year. The shift towards natural gas might not be a good bet, because the EIA projects natural gas consumption will decline by 2.2% during 2014. The expected fall in consumption is mainly due to lower demand for natural gas in the power and residential sectors. Taking into account the outlook of these coal companies, let’s turn to their current valuation in order to determine which investment could be a bargain.

The price of coal companies

In order to compare the valuation of the above-mentioned coal companies I used their enterprise value-to-EBITDA ratios. The table below summarizes the data of CONSOL Energy, Alliance Resource Partners, Peabody Energy and the average coal industry.

valuation Coal  Jan 2014

Source of Data: Yahoo Finance and Damodaran’s site

The EV-to- EBITDA ratio takes into account these companies’ different financial structure such as their level of debt. E.g. CONSOL Energy’s debt-to-equity ratio is 0.83, while Peabody Energy’s debt-to-equity ratio is 1.34. This means, Peabody Energy’s financial risk is higher than CONSOL Energy’s. Based on the above, all three companies’ EV-to-EBITDA ratios are far apart form each other and from the industry average. Alliance Resource Partners’ ratio is the lowest at 5.16, while Peabody Energy’s ratio is the highest at 24.3. The valuation of Peabody Energy is high even though the company’s stock tumbled down by more 23% during 2013. These findings suggest, at face value, that Alliance Resource Partners is well priced compared to its peers. Bear in mind, however, that since Alliance Resource Partners is a limited partnership it also has different taxation rules than a regular company. Here is a fool article that summarizes the basics for investing in limited partnership.

Foolish bottom line

The coal industry is expected to recover in 2014, which will benefit leading coal companies. Some coal companies such as CONSOL Energy are changing their business towards natural gas and might not benefit from the rally of coal as other coal producers including Alliance Resource Partners and Peabody Energy will. Finally, given the low valuation of Alliance Resource Partners, this limited partnership might be an investment worth considering.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.