Yesterday, I went into my backyard to grill some tasty treats, as it was a pleasant evening and…well…grilled food be good. As I cleaned out my Weber to start my fire, I went into my shed to pick up some fuel for the fire…lo and behold nothing was there. My coal was stolen.
I figured…why steal coal now? I mean, coal shares are in the midst of a nasty correction…why in the world would anyone want to try to catch that falling knife? In such a situation most people would have just went out and bought more charcoal…but not me. I had a hunger…but not for burgers.
Here are some links to recent earnings reports of Massey Energy, Arch Coal, and Peabody Energy:
Sure there are other coal companies, but I will focus on these three widely helds as I have followed them for some time. These are impressive results to be sure. Yet these shares have declined 20 – 40% from their highs. Technically speaking, such activity in the face of good news screams slowing growth going forward. Never mind some of these quotes from earnings calls:
Coal consumption within the United States has risen an estimated 13 million tons in 2008, and coal exports are up an estimated 10 million tons year to date. Yet coal production has only increased 5 million tons. As a result, U.S. generator stockpiles, which are already 17 percent below prior-year levels on a days-use basis, are being reduced at a rate of 2 to 3 million tons per week. Stockpile reductions are likely to accelerate through the third quarter, due to seasonal use and growing exports, and are expected to be below targeted levels by the end of summer. (Source: Peabody Energy’s results quarter end June 30)
Furthermore, continued strength in the international coal marketplace is contributing to strong domestic coal market conditions. Based on U.S. Department of Commerce data, coal exports reached 32.0 million tons through May – a 56 percent increase from the prior year five-month period. At the same time, coal imports into the United States totaled 13.3 million tons through the first five months of the year, nearly 6 percent below the prior year-to-date import levels. As a result, Arch now estimates a 4-million-ton decline in U.S. coal imports for 2008, while raising its forecast for U.S. coal exports to 83 million tons, which represents a 24-million-ton increase over last year’s improved levels. (Source: Arch Coal’s results quarter ended June 30)
Pricing for Massey’s core products was very strong in the second quarter and remains so to date.
– Eastern U.S. steam coal prices increased dramatically during the second quarter, driven by continued strong demand from the export market. Pricing for prompt delivery NYMEX spec coal increased approximately 85 percent from March 31 to June 30, ending the month and quarter at nearly $140.00 per ton.
– Prompt delivery coal prices for 12,500 btu steam coal continue to be $150.00 to $160.00 per ton in July and we believe the underlying market fundamentals remain unchanged. Global supply of coal remains tight and demand for coal is increasing.
– Benchmark prices for metallurgical coal have been established at $300.00 per metric tonne, FOB terminal. Massey has been able to sign supply agreements at this price.
“During the quarter we made extensive visits to some of the world’s most rapidly developing countries,” Blankenship added. “Based on discussions with customers and potential customers, and visits to several power and coke construction projects, I came away convinced that the world’s need for coal will continue to grow at a rapid rate. The high quality and diversity of the coal we produce as well as our leading market position in Central Appalachia will enable us to compete effectively to serve these growing export energy markets. We are very pleased with our market and production positions and our opportunities to grow our business with both new and existing customers. We are particularly pleased to have reached agreements on several multi-year deals to supply coal to Asian customers.” (Source: Massey Energy’s results quarter ended June 30)
One look at these charts tells the story (as of Aug 11 2008):
Compared to 50 day MA’s on the weekly charts we are at significant trend/price levels, aside from Massey, which is not yet near it’s 50 day:
Also, recently Massey filed for financing via convertible notes and a common stock offering primarily to retire higher interest debt as well as for expansion projects.
Why expand? Check out these coal prices.
And the source, of course:
It is interesting to note the relative lag of PRB coal pricing. This is due in part to the difficulty in shipping this coal overseas due to the prohibitive cost…nearly all of this coal is used for U.S. consumption, and pricing is subject not only to depressed economic conditions, but also to its relatively low energy yield relative to other coal grades.
In addition, Massey is the largest producer of Appalachian coal…the coal primarily used for exports as the shipping logistics are conducive to such activity. Here are some figures on the levels of coal exports/imports:
In a recent analyst presentation by BTU the following points were made:
- 1B tons of coal consumption to be generated by 300 GW of new coal plants
- India’s coal minister predicts 265 million tons per year needed by 2012…or over 20% of current U.S. production
- From 2003 to today Chinese coal exports have gone from 80M tons to nearly zero
Source: BTU Analyst Breakfast 8/6/08
The info naturally is to be taken with a grain of salt as it is a sell side presentation…yet these dynamics indicate the fundamentals are screaming strength.
Expanding production at all time high prices is very risky. Yet the recurring theme throughout all of the earnings reports is the unyielding price increases for thermal and metallurgic coal due to demand pull and supply constraints. Furthermore, the pricing environment is causing coal companies to remain levered to the coal market…significant unpriced volumes exist for 2009 and virtually all volumes remain unpriced for 2010. Scary…but evidently these executives understand an industry dynamic ahead that we may not.
What kind of shape are these companies in, you ask? Well, actually, all are quite similar. All are using debt to finance expansion, with Debt/Equity ratios over 1 and Current and Quick ratios under 1, aside from Massey, which has Current and Quick Ratios over 1 and hence a more solvent standing. Debt levels of all companies have been relatively stable. The reduction of CFI from 2007 and in Massey’s case into 2008 is noteworthy. This confirms the recent Debt and Equity offerings to manage capital spending and debt retirement. A constant theme in all earnings reports has been the elevated costs per ton, which is sure to create margin pressure. Yet coal price increases have been able to mask this, and surely is expected to mask this in the not too distant future. Consensus analyst estimates in 2009 for BTU are $6.08/share, for MEE $6.92/share, and for ACI $6.36/share. This is a simple industry, folks, in terms of the profit center…coal rises, profits rise. So the “back of the napkin” calculation says that if production and costs were to remain constant, average prices per ton for coal would have to double in the next 18 months (remember the unpriced volumes) to meet those estimates.
What we are seeing is, well…striking when the coals are hot (I could not help it); leveraging debt and equity issuance in order to expand capacity to meet anticipated demand and elevated prices. The logic here is to create additional economies of scale via expanded delivery capacity (expansion of Australian ports, rich in metallurgic coal) and swing capacity (U.S). Furthermore much margin growth is coming out of Australia relative to the U.S., while the wild card is the anticipated pull resultant from depressed PRB pricing. As prices increase and supply becomes more prohibitive, PRB coal will see more widespread usage among overseas customers.
I find it very ironic that growth for this old industrial is spoken of in terms reserved for Silicon Valley icons and sun catchers, but alas here we are. This industry is growing so rapidly that conventional measures of solvency and risk management need to incorporate the measures taken by these companies to expand capacity to leverage the favorable demand and supply profile for coal.
OK, enough fundamental psychobabble…what about these stocks? Well…don’t fight the tape…I agree with that assertion. But do not be scared of it. Hedge short…but do not get caught short. These fundamentals are too strong to short…nevermind the recent selloff. If you have been short…congratulations you are a trader with great timing. Yes this tape has been ugly for coal and commodities in general, and may continue to be so. The long argument here is very compelling, and remember that you will never catch the bottom so holding through pain will be necessary.
So…for Xmas this year…I am wishing that Santa will bring me big lumps of coal. Most likely I will be back to net zero…with the current coal shortages worldwide, it probably was Santa who stole my Kingsfords in the first place to fill his orders…
Disclosure: Author is long BTU
