Alpha Natural Resources‘ (NYSE:ANR) stock has tumbled nearly 70% since the beginning of the year and was the worst performer among coal stocks except Patriot Coal Corporation (PINK:PCXCQ), which filed for bankruptcy. The dismal performance has more to do with the industry slowdown rather than Alpha’s strategy. However, the poor performance of the stock compared to the industry can be attributed to additional losses from Massey’s operations and the controversy surrounding Massey’s mines.
Alpha’s completion of the Massey Energy acquisition last year was immediately followed by a slowdown in the domestic coal market. As a result, management had to deal with the bleak climate for coal instead of focusing on merger synergies. However, we are still optimistic that the Massey acquisition will prove worthwhile in the future. Separately, met coal demand has also taken a pounding of late, primarily due to a decline in demand from China. We believe that the coal market will start to revive gradually when natural gas prices eventually rise and met coal markets improve on improving global economic conditions. The stock is currently heavily depressed and we expect that any near-term jumps will come from some positive news for the industry as a whole.
We have a price estimate of $9 for Alpha Natural Resources, implying a 30% upside to the current market price.
Our Stance On Alpha’s Utility & Industrial Coal Division
Utility coal prices have been falling of late, imitating the decline in the prices of natural gas, which is considered the closest alternative for coal. The trend is likely to continue in the near future as it is believed that thermal coal consumption will decline in 2012 by nearly 120 million tons compared with last year, which would likely drive coal prices further down. The general perception of coal usage has drastically changed recently as coal is less environmentally friendly than natural gas. The Environment Protection Agency has been harsh on coal. It requires that all upcoming power plants adhere to more stringent standards for carbon emissions. This could lead utility companies to build more gas-fired plants than coal-fired plants. Therefore domestic demand for utility coal is likely to remain tight in the near term.
Further, the company’s utility coal division is heavily reliant on domestic consumption patterns. The share of utility coal in Alpha’s coal export portfolio is negligible. However, of late, the company is increasingly pushing its thermal coal exports, but it will take some time before exports can compensate for the domestic plunge. Moreover, its export facilities are limited.
Demand for coal globally is different from that in the U.S. There has been increased consumption of coal in Europe, and even Asian markets are not primarily met coal markets anymore. Asian demand for thermal coal has been rising due to increased levels of urbanization and industrialization. Europe, on the other hand, has sufficient coal demand, but has been facing an economic crisis and Alpha mentioned earlier that it was renewing contracts with many European companies at a discount. We expect coal prices as well as volumes to remain suppressed in the near term, though we expect a long-term reversal.
Increasing natural gas prices bode well for Alpha. Coal demand may rebound earlier than anticipated if gas prices rise significantly, in which case our estimates could see some upside. Further, Alpha received significant reserves in the Central Appalachia region after acquiring Massey in 2011, which can be well mined if and when coal prices increase. However, presently the company is focused on stalling high cost mines and cutting operational expenses.
Our comparatively bullish estimates are largely due to the evolving global thermal coal market and the premise that a further increase in gas prices will likely lead some utility companies to opt for coal-fired power generation over gas-fired generation.
Our Stance On Alpha’s Metallurgical Coal Division
Unlike utility coal, Alpha’s metallurgical coal franchise is heavily reliant on export demand. Lately, the slowdown in Chinese and European demand and the availability of cheaper grade met coal have pulled prices down globally. Most of the developing countries in Asia, including India and China, have encountered inflationary pressures that led their governments to tighten the liquidity in the system. This has had an impact on the investment climate in these regions. Accordingly, we reduced our forecasts for near-term met coal prices as well as volumes from our previous estimates. However, we believe these factors are temporary in nature, and we expect the met coal market to rebound earlier than the utility coal market. These have been factored into our estimates for the prices and volumes of met coal for Alpha in this division.