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Coal Industry Outlook - May 2018

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The coal industry has been losing its charm with increasing emphasis on reduction in carbon emissions. 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 President Trump, who 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. Moreover, the global banking and financial services provider HSBC Holdings plc. (HSBC - Free Report) said that it will stop funding new coal power plants across the globe, except projects in Bangladesh, Indonesia and Vietnam. The action will align the bank policy with the Paris Agreement.

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.

All major U.S. coal producers have been affected by a 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.

Thanks to coal industry-friendly moves by the new government and the ensuing change, we have seen Arch Coal Inc. (ARCH - Free Report) and Peabody Energy (BTU - Free Report) successfully completing their financial restructuring and trading again.

The recent release by the International Energy Agency (“IEA”) 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 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 62 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 17 coal companies presently in our coverage, Contura Energy Inc. CNTE and Warrior Met Coal, Inc. (HCC - Free Report) sport a Zacks Rank #1 (Strong Buy), and the remaining stocks have a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank  stocks here.

Trading at a Discount vs. S&P 500

The valuation of the industry looks inexpensive at present. The industry is currently trading at 9.99x P/E. This looks quite inexpensive compared to its traded multiple range of the S&P 500 (17.7x).

The Zacks Coal industry has gained 30.6% in the past year compared with the S&P 500’s return of 13.4%.

Earnings Review & Outlook

Out of the 17 coal companies in our coverage, five have come up with average first-quarter positive earnings surprise, with all witnessing an upward revision in earnings estimates for the current year. Apart from these, estimates of another four companies moved north for the current year.

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 far cheaper than other fuel sources.

President Trump no doubt has brought in some hope for this industry in the difficult times. 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 a Bureau of Labor Statistics release, nearly 2,300 jobs were added in the coal industry till April 2018 from the time the new administration took charge. This is a welcome change from a drop in coal jobs noticed during the major part of 2016.

Per U.S. Energy Information Administration (“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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