Coal Industry Stock Outlook - October 2016

Even though increasing environmental regulations have been dampening the demand for coal in recent times, there are many who still appreciate the fossil fuel as a cheap source of power generation.

In spite of its declining share in the energy generation mix, the truth is, coal still holds a prominent place and will continue to do so for the next few decades.

Coal is currently mined in more than 50% of U.S. states. The top five coal-producing states – Wyoming (40% of the total), West Virginia (11%), Kentucky (8%), Illinois (6%) and Pennsylvania (6%) – contribute the major share of the total coal production of the country, per reports from the U.S. Energy Information Administration (EIA).

Unfortunately, all major U.S. coal producers have been affected by the drastic fall in demand and consequently its prices. Prices of major coal companies have taken a beating, so much so that reverse stock splits could not help Peabody Energy Corp. and Arch Coal from bankruptcy and delisting. Even with the demand decline, coal continues to occupy an important position in the fuel mix for electricity generation and is expected to hold its place for the next few decades.

Coal remains a dominant source of power generation worldwide despite the increasing use of other sources. However, natural gas and renewables are eating away coal’s share at a rapid pace. The new Clean Power Plan, announced in Aug 2015 by the U.S. Environmental Protection Agency (EPA), calls for CO2 reduction of 28% by 2025 and 32% by 2030, from 2005 levels. This plan will ensure the closure of more coal-based power units. They will either be idled or converted to natural gas-based units, affecting the long-term prospect of coal stocks.

Coal and its various byproducts also find use in the industrial sector, underlying its manifold advantages. However, unchecked usage of this fossil fuel has raised concerns in all quarters. The primary cause of concern related to coal is global warming caused by the emission of greenhouse gases.

Zacks Industry Rank: Positive Outlook

Despite the ongoing weakness in coal demand, cost of generating electricity from the fossil fuel is still the cheapest among all other sources. Per a recent EIA release, electricity generation fuel costs (dollars per million Btu) will be $2.16 for coal, compared with $3.02 for natural gas in 2016. For 2017, the fuel cost is expected to be $2.24 for coal and $3.61 for natural gas. It’s thus evident that coal continues to enjoy price advantage over other sources of electricity generation.

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 33 out of 258 industries in our expanded industry classification. This puts the industry in the upper third of all industries, corresponding to a positive outlook.

The way to look at the complete list of 258 industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, the middle one-third of the list (Zacks Industry Rank of #86 to #169) is neutral while the outlook for the bottom one-third (Zacks Industry Rank #170 and higher) is negative.

Please note that the Zacks Rank for stocks, which is at the core of our Industry Outlook, has an impressive track record going back years, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months).

Of the 16 coal companies presently in our coverage, four stocks sport a Zacks Rank #1 (Strong Buy) and one carry a Zacks Rank #2 (Buy).Hallador Energy (HNRG) currently has a Zacks Rank #1. Its 2016 and 2017 earnings estimates have moved up by 1.7% and 228.6%, respectively, in the last 60 days.

You can see the complete list of today’s Zacks #1 Rank stocks here.

CNX Coal Resources LP (CNXC) also sports a Zacks Rank #1. Its 2016 and 2017 estimates improved 10.3% and 18.2%, respectively, over the last 60 days.

Meanwhile, another eight stocks have a Zacks Rank #3 (Hold) and other three carry a Zacks Rank #4 (Sell).

Earnings Review & Outlook

The coal industry’s overall results in the second quarter of 2016 were mixed, with nearly 50% lagging estimates but other 50% exceeding expectations.

Hallador Energy and Cloud Peak Energy (CLD), currently sporting a Zacks Rank #1, have both surpassed second-quarter earnings estimates by a respective 1050% and 237.1%.

Suncoke Energy (SXCP) and Westmoreland Coal Co. (WLB), two Zacks Rank #4 stocks, however, missed earnings expectations last quarter by 46.5% and 1,345.5%, respectively.

In response to lackluster coal market fundamentals, the companies have resorted to stringent measures to improve their financial performance. Miners have taken initiatives to cut costs while engaging in tactful expenditures to ensure coal-mining safety. High-cost coal mines are being shuttered while operations are moved to low-cost regions.

Miners have taken the extreme decision of selling some coal mines and cutting jobs to lower operating costs. Longwall coal mining techniques are also having a positive impact on production. The marketing teams of coal companies have also been working hard to secure new contracts and renew existing long-term contracts.

If there is a bright spot for these coal mining firms, it is the rising demand for coal from India. Coal production in India falls far short of its domestic requirement as most of its power units are still run on this fossil fuel. The country will have to rely on imports to sustain its growth plans. In fact, India has surpassed China in 2015 as a major thermal coal importer, and demand for coal is on the rise in spite of its goals of adding a huge volume of solar energy in the system.

India needs to import both thermal and metallurgical coal, providing ample room for U.S. exporters to vie for. However, the lower-than-expected growth rate in China and the accompanying fall in thermal coal demand are causes of concern for global coal exporters.

For a detailed look at the third-quarter earnings outlook for the different sectors in our coverage, please check our weekly Earnings Preview report.

Bottom Line

Undoubtedly, coal stocks are bleeding and some presume they won’t survive in the long run. Loads of negative factors are bringing coal down; do these companies have the resources to fight back successfully? We all know for a fact that coal reserves at the current pace of production and consumption will last longer than all other fossil fuel resources.

Unlike renewables like wind and solar that rely on nature’s whims for the production of energy, coal-based power plants provide stability to the performance of the grid. Coal is still far cheaper than other fuel sources.

Admittedly, coal has a long list of drawbacks. Even so, coal will still account for nearly 30% of the electricity produced in the U.S. in 2016 – not a bad achievement for an industry that has been under tremendous pressure from cheap natural gas and booming alternative energy sources.

With natural gas prices expected to increase further from present levels, the EIA forecasts coal’s share in the electricity generation mix will improve from 2016 levels and touch 31% in 2017. And lest we forget, its cost advantage and wide availability in most countries across the world make it a widely accepted source of power generation.

Confidential from Zacks

Beyond this Industry Outlook, would you like to see Zacks' best recommendations that are not available to the public? Our Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Click to see them now>>

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
WESTMORELAND CO (WLB): Free Stock Analysis Report
SUNCOKE ENERGY (SXCP): Free Stock Analysis Report
HALLADOR ENERGY (HNRG): Free Stock Analysis Report
CNX COAL RESRCS (CNXC): Free Stock Analysis Report
CLOUD PEAK EGY (CLD): Free Stock Analysis Report
To read this article on click here.
Zacks Investment Research

Comments on SXCP stock