Coal: When Tax Loss Selling is a ‘Better Opportunity Than Hanging On’

Should investors be afraid of coal stocks like Arch Coal (ACI), Alpha Natural Resources (ANR) and Peabody Energy (BTU)? Yes, unless they happen to be very long-term investors, says JPMorgan’s John Bridges and team:

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The coal equities have fallen two-thirds from their 2011 peak as supply has overtaken faltering demand. We remain convinced that coal is an essential base load fuel source for the US and other's power grids. This situation is probably offering opportunities for farsighted investors. It was interesting that recently Chris Cline secured control over 480mt of permitted coal in Canada. Last year, Kinder Morgan announced plans to buy royalties on coal so it could benefit at the exports ports and at the source of the coal. Without seeing any near term catalysts that can lift coal prices and with their often elevated debt levels buying the listed equities is a more risky strategy. We do see real long term value in the coal equities with the better balance sheets. However, given the growing supplies of nat gas, without a chilly winter, gas prices could weaken further, and create a better buying opportunity for the coal space. In this environment, coal bulls seems to have been seeing tax loss selling as a better opportunity than hanging on, and deep value buyers are failing to see positive catalysts…

Until mid-2014 the best performers had been the thermal producers Alliance Resource Partners (ARLP) Cloud Peak Energy (CLD) and Consol Energy (CNX), but since nat gas prices disappointed in July, there's no safe equity in the sector. With booming supplies of nat gas, a demand still playing catch up, without a cold winter gas prices could be weak into 2015.

As for Arch Coal and Alpha Natural resources, Bridges dubs them the “terrible twos.” He explains why:

…after falling from peaks of $67 and $36 respectively, both Alpha and Arch now trade with a $2 handle. The stocks are essentially trading as options on a coal sector recovery while some of their higher risk debt is sending a message by trading between $.60 and $.70 on the dollar. Arch has $4.2bn of net debt carried by $0.47bn of market capitalization while Alpha is only half as leveraged…However, both companies have balance sheet liquidity and have pushed out debt maturities to give themselves time for the coal market to recover. The only thing missing is the catalyst. Peabody has relatively more balanced financials with net debt to market cap of 1.6x but still feels uncomfortable with its debt.

Still, while Bridges leave Arch Coal and Alpha Natural Resources without price targets, his targets on Peabody, Cloud Peak and Alliance Resource are all well above their current prices.

Shares of Peabody Energy have fallen 0.5% to $12.02 at 3:47 p.m. today, while Alpha Natural Resources has slid 4.7% to $2.25, Arch Coal has gained 0.5% to $2.10, Cloud Peak Energy has dropped 0.7% to $12.23, Consol Energy has advanced 1% to $37.42 and Alliance Resource has declined 1.6% to $43.56.