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Coal Industry Outlook - January 2018

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The U.S. coal industry has faced stringent environmental regulations over the last few years. However, conditions have started to change for the better after the election of the Trump administration, which wants to revive the industry and relax regulations. The new administration has initiated steps to remove the restrictive provisions of the Climate Power Plan and has already walked out of the Paris Climate Agreement.

But the industry’s problems aren’t restricted to regulatory hurdles alone — coal faces a far stronger challenge from natural gas. What this means is that coal’s competitive position will remain challenged even as the regulatory landscape is starting to become less onerous.

The Climate Power Plan and Paris agreement have the same objective of lowering emission levels. Coal usage to generate electricity and in other heavy manufacturing industries are the primary sources of greenhouse gas emissions. Thanks to coal industry-friendly moves by the new government, a rise in price of natural gas coal production in the United States increased 6% year over year in 2017 to 773 million short tons, per a release by the U.S. Energy Information Administration (“EIA”).

However, per the EIA, gains in the U.S. coal industry are expected to be short lived, and the coal production in 2018 is expected to drop 1.9% year over year and further decline 2.4% in 2019. The primary reasons behind for this are drop in U.S. coal exports and decline in usage of coal in electricity generation in the United States.

All major U.S. coal producers have been affected by the drastic fall in demand, and consequently prices have dipped. The coal companies have tried different ways — like cutting production, idling coal mines, lowering expenses, selling off coal mines and producing coal from low cost mines — to remain commercially viable.

Due to the continuation of difficult times resulting in a drop in coal demand and prices, some major coal companies were forced to file for bankruptcy protection. However, with the gradual change in the coal industry we have seen Arch Coal Inc. ARCH and Peabody Energy (BTU - Free Report) successfully completing their financial restructuring and trading again.

The recent release by the International Energy Agency forecasts global demand to remain flat between 2017 and 2022. The drop in demand for coal in China, European Union and the United States is being filled up by the increase in demand for coal in India and some countries in South East Asia. We believe that it is a positive forecast for coal as it is able to retain a stable global demand despite strong competition from other sources of fuel.

Coal and its various byproducts also find use in the industrial sector, underscoring its manifold advantages. However, unchecked usage of this fossil fuel has raised concerns in all quarters, especially those concerned with carbon emissions leading to greenhouse gas effects.

Zacks Industry Rank: Positive

We rank the 265 sub-industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries in two groups — the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than two to one.

The Zacks Industry Rank, which relies on the same estimate revision methodology that drives the Zacks Rank for stocks, currently puts the coal industry at 84 out of 265 industries in our expanded industry classification. This places the industry in the first group, corresponding to a positive outlook. President Trump’s coal-friendly initiatives will have some positive impact on the industry.

Of the 16 coal companies presently in our coverage, Cloud Peak Energy CLD and Peabody Energy sports a Zacks Rank #1 (Strong Buy) and two stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Among the remaining coal companies in the space, 10 carry a Zacks Rank #3 (Hold), one carries a Zacks Rank #4 (Sell) and one has a Zacks Rank #5 (Strong Sell).

Trading at A Discount vs S&P 500

The Zacks Coal industry has gained 23.8% last year compared with the S&P 500’s return of 26.5% in the same time period.

The valuation of the industry looks inexpensive at present. The industry is currently trading at 11.03x P/E multiple. This looks quite inexpensive compared to its traded multiple range of the S&P 500 (19.51x).

Earnings Review & Outlook

Out of the 16 coal companies in our coverage, five have come up with average four-quarter positive earnings surprise with three witnessing an upward revision in earnings estimates for the current quarter.

Contura Energy CNTE, carrying a Zacks Rank #3, surpassed third-quarter estimates by 29.08%. Its 2017 estimates have moved up 15.6% to $7.61 while its 2018 estimates have increased 20.5% to $12.82 in the last 30 days.

Miners have taken initiatives to cut costs while engaging in tactful expenditures to ensure coal-mining safety. Further, high-cost coal mines are being shuttered while operations are moved to low-cost regions. Longwall coal mining techniques are also having a positive impact on production. The marketing teams of coal companies have been working hard to secure new contracts and renew existing long-term contracts.

Bottom Line

Coal stocks are suffering but we know for a fact that coal reserves at the current pace of production and consumption will last longer than all other fossil fuel resources. Further, coal is still far cheaper than other fuel sources.

President Trump no doubt has brought in some hope for this sinking industry. Plus, big names coming out of bankruptcy indicate a gradual turnaround of the coal group. Even though the damage done to this industry has yet to be compensated fully, the positive changes are already noticeable.

Per EIA, coal will still account for nearly 30% of the electricity produced in the United States in 2017 and fall slightly below 30% in 2018  — not a bad achievement for an industry that has been under tremendous pressure from natural gas and booming alternative energy sources.

We still believe that coal’s cost advantage and worldwide availability make it more commonly accepted source of power generation.

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