Will These Coal Companies Recover?

Peabody Energy (NYSE:BTU) and Arch Coal (NYSE: ACI), leading coal producers, have recently released their fourth quarter earnings reports and updated their 2014 guidance. These reports didn’t impress their investors and these companies’ stocks have tumbled down in the past several weeks. Looking forward, however, will these coal companies recover in the coming months? If the coal industry rallies in 2014 will these coal companies benefit from it?

Fourth quarter results

The recent earnings reports of Peabody Energy and Arch Coal showed another dip in their revenues and higher losses. Arch Coal’s revenue plummeted by 17% during the fourth quarter, year over year; Peabody Energy’s revenue, by 41%. Both companies’ operating earnings were in the red. A big chunk of these losses, however, were due to goodwill provisions and other non-cash assets impairment costs, which were recorded in the fourth quarter. After controlling for these provisions, Peabody Energy’s operating loss falls from $552 million to $17.5 million — nearly eliminates the company’s entire quarterly loss.  Arch Coal’s operating earnings declines to $75 million. This means, while these companies’ operations are still losing money, the situation isn’t as dire as the earnings reports suggest.

In terms of output, Peabody Energy’s production rose by 2% during the last quarter of 2013 mostly in the U.S. In Australia, the company’s production inched down. The main reason for the drop in revenue was the sharp fall in prices in the U.S and especially in Australia.

On the other hand, Arch Coal cut down its production by over 10% in the last quarter of 2013. The average price of coal also tumbled by 17.8% during the fourth quarter. As a result of the plunge in coal sale prices, the company’s operating margin turned from a $1.33 per ton profit in the last quarter of 2012 to a $1.19 per ton loss in the fourth quarter of 2013. This shift doesn’t vote well for the company’s operations and reduces its valuation.

The ongoing fall in margins led coal producers to cut down their coal operations: During 2013, CONSOL Energy (NYSE:CNX) sold its five West Virginia Longwall coal mines. Such steps are projected to reduce the company’s coal sales by 47% in 2014. Further, the company expects to increase its natural gas operations by 30% in 2014, year over year. But unlike CONSOL Energy, Arch Coal and Peabody Energy remain in the coal business.

Looking forward for 2014, Arch Coal plans to inch down its annual production by 1.9% to reach 137 million tons of coal. It also plans to slash its capital expenditure by 36% to roughly $190 million. Peabody Energy’s outlook is a little less grim: It plans to slightly increase its production by 1.3% and its capital expenditure is set to fall by less than 8% to $300 million. So even though Peabody Energy plans to slightly increase its production, both companies are expected to reduce their capital spending.

The main uncertainty will remain the price of coal that will determine not only these companies’ revenues but also their profit margins. So what’s next for coal?

Coal in 2014

According to the U.S Energy Information Administration recent outlook, during 2014 , the U.S coal production is projected to rise by 3.9% to reach 1,035 million short tons. The rise in production is expected mainly due to the 3.5% rise in local demand. The rise in demand for coal could also facilitate higher volumes of coal sold by Arch Coal and Peabody Energy. Despite the projected rise in demand for coal, the price of coal is expected to be around $2.36 per million Btu – nearly a 1% drop from 2013. This won’t help Arch Coal and Peabody Energy improve their earnings.

But in the first quarter of 2014, the price of coal might have a short term recovery if the price of natural gas remains at its currently high level.

Natural gas and coal

In recent weeks the price of natural gas spiked to pass the $5 mark. The colder than normal weather has increased the demand for natural gas. As a result, utility companies are forced to pay high prices for natural gas. These developments might shift back the demand towards coal and thus help rally its price at least during the winter time. In such a case, coal companies might see a modest rise in their operating earnings in the first quarter of 2014. But these high prices are likely to come down in the coming months; thus these turn of events will only have a short term positive effect on the price of coal.

Bottom line

The coal industry is projected to rally in 2014, which will benefit several coal companies. The recent colder than normal weather in the U.S pressured up the price of natural gas, which, in turn, might have also positively affect the price of coal in the first quarter of 2014. Despite the potential rise in demand for coal, its price is still expected to fall in 2014. Peabody Energy and Arch Coal continue to face narrower profit margins and tougher competition. Therefore, while coal might still offer some viable investments opportunities in 2014, Peabody Energy and Arch Coal might not offer enough to make them 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.