Many coal stocks have surged in price in October, primarily because of rising coal prices overseas and improving production volumes in the U.S.
Shares of Peabody Energy (BTUUQ), which is still in bankruptcy, surged more than ten-fold in just ten days, from $1.71 on October 14 to an intra-day high of $18.75 on October 24. They have since settled down to $8.75, which is still more than five times the October 14 price.
Similar moves, though not nearly as dramatic, can be seen in the charts of Rhino Resource Partners (RHNO), Foresight Energy, LP (FELP) and SunCoke Energy (SXC). Shares of Alliance Resource Partners (ARLP) and Cloud Peak Energy (CLD) have not quite spiked, but they are still up 12.7% and 13.2%, respectively, for the month.
The extremely strong performance of coal shares relative to the broader market stands in marked contrast to the performance of the Dow Jones U.S. Coal Mining Index, published weekly in Barron’s, which is down 11.7% for the month. As far as I can tell, that index now includes only one stock, Consol Energy (CNX), which ironically has reduced its exposure to coal mining to focus on natural gas production. I suspect that S&P Dow Jones Indices was forced to pull most of the stocks out of the index because of bankruptcy filings over the past two years, but it has not yet made an effort to reconstitute the index.
The sudden rise in coal mining share prices has been sparked by a surge in prices overseas for both thermal and metallurgical coal, which can be seen in the Newcastle (Australia) benchmark. Through Oct. 24, Newcastle thermal coal prices were up 27% to nearly AU$98 per tonne since the start of the month, while met coal prices were up 15% to AU$245 per tonne, according to mining.com.
The rise in coal prices is mostly attributable to a sharp increase in buying from China, which had throttled domestic coal production in an effort to reform the industry. Since the summer, China has turned to coal imports in order to rebuild stockpiles ahead of the winter heating season. Both the decline in China’s production and its stepped up buying are expected to reverse, which has put the coal futures curve in contango, a clear indication that prices will fall back in the months ahead.
In the U.S., coal miners have been digging out of the hole in production caused by low natural gas prices (which has prompted most utilities to favor running their natural gas-fired power plants over coal) and last year’s unusually warm winter weather. Since April, as utilities have worked off their coal inventories and weather has returned to normal, production has risen.
At the low point (in April 2015), coal production was running nearly 40% behind prior year levels. Since then, production has risen steadily so that it was just 6% below last year at the latest reading (Oct. 22). As the year comes to a close, production comparisons should run ahead of last year and comparisons should remain favorable until at least the middle of next year.
The steady gains in production will result in improved quarter-to-quarter earnings comparisons when coal miners report their third quarter results. The rise in production this quarter will generate a big improvement in operating margins, as fixed costs are spread over higher volume, even though average sales prices are little changed. Yet, year-over-year earnings comparisons for the third quarter will be flat at best for most miners.
The sharp rise in Peabody Energy’s share price is worth noting. At the current price of $8.75, the stock is trading at a level last seen at the end of 2015, four months before the company filed for bankruptcy. It is noteworthy that as its share price was spiking in mid-October, Peabody appeared before the bankruptcy judge to ask for an extension of its exclusive right to file a reorganization plan. At that hearing, the court extended the exclusivity period to December 14.
If Peabody’s share price were an accurate reflection of its future prospects, the company might have instead asked the judge for permission to withdraw its bankruptcy filing. Although it is highly likely that 2017 will be a better year for Peabody (and the rest of the industry), it probably will not be dramatically better (at least not good enough to skip bankruptcy altogether). The industry still faces significant challenges, including a seemingly unending stream of coal-fired plant closure announcements and an ongoing cost advantage for natural gas-fired power plants. A setback in the economy could also reduce electricity demand and forestall further improvements in coal demand.
Against that backdrop, the sharp rise in the share prices of Peabody and other coal producers seems premature. In Peabody’s case, the announcement that Mangrove Partners has taken a 5% stake in the equity raises hope that equity investors will at least have a seat at the table in its bankruptcy plan negotiations (which to date is more than investors in other bankrupt coal companies have had). The steady improvement in production also raises hope that the estimated value of the company under the bankruptcy plan will be high enough to give equity investors a meaningful recovery. (In all of the previous coal company bankruptcy reorganizations, the existing equity has been wiped out.)
Yet, $8.50 for Peabody today seems like a stretch. In my view, it would likely prove to be sustainable only if all of Peabody’s debt is effectively reinstated. (At last check, Peabody’s unsecured bonds were trading in the low 40s.) Reinstatement might happen if someone were to bid for the entire company, which is possible but not probable at this time in my view. At current price levels, therefore, I would take the unsecured bonds over the equity.
That said, I do believe that the equity of reorganized coal companies will eventually be worth a multiple of current prices. To get there, however, those who buy now must be willing to endure what could be a fairly long and bumpy ride.
October 31, 2016
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
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