This time of year, a lump of coal is generally viewed as something for the naughty crowd. But over the long term, a small amount of exposure to the ailing U.S. coal industry might prove nice for investment portfolios.
In 2010 and 2011, the coal industry, which supplies coal-fired power plants as well as steel plants, had a good head of steam amid a strengthening U.S. economy and projections of strong growth in China, India and other emerging markets. But over the last five years, the Dow Jones U.S. coal index has lost more than 95 percent as utilities switched to cheap natural gas, China has imported less than expected and India has been able to supply its own coal needs from internal production.
The political and social environment has also not been kind to coal, as large investors such as pension funds and government organizations have committed to divesting themselves of fossil fuels. The Environmental Protection Agency issued the Clean Power Plan that would limit carbon emissions from existing power plants.
This year alone has seen three high-profile coal company bankruptcies, with Patriot Coal Corp., Walter Energy and Alpha Natural Resources seeking Chapter 11 protection.
Coal isn’t going anywhere, really. But America’s coal addiction isn’t going to completely go away for some time. Last year, the commodity provided 39 percent of the nation’s electricity, making it the biggest source of power in the U.S., according to the Energy Information Administration. At some point, low valuations for coal companies could become a bargain opportunity, experts say.
Dennis Gartman, an investor and publisher of the The Gartman Letter, an advice publication primarily for institutional investors, says buying coal is a contrarian stock pick. Coal-fired generation probably won’t go below 25 to 30 percent of the nation’s electricity mix over the next 10 years, Gartman says, perhaps only totally being phased out within the lifetime of millennials.
Because the nation has no choice but to use coal for years to come, buying a cheap coal stock, holding it for a decade and reaping its cash flows as the company continues to produce could prove a good strategy, Gartman says.
Gartman thinks coal stocks have been bouncing around the bottom over the past year, and now may be a good time for bargain-hunting investors who want to use domestic coal as a long-term investment. He recommends limiting exposure to coal at 1 or 2 percent of a portfolio.
However, Anthony Young, a Macquarie Group analyst, says it is too early for retail investors to be involved in coal, even though the coal market still has a role to fill in the U.S. energy supply chain.
With natural gas prices at less than $2 per million British thermal units, utilities have no incentive to burn more coal in 2016 than they did this year.
Young sees potentially two or three more coal company bankruptcies over the next year. He recommends staying away from the sector while the remainder of its pain plays out over the next 12 to 18 months.
Stocks to buy to play the coal sector. Young sees only a few companies coming out of the coal downturn as public entities with $100 million or more in market capitalizations without resorting to bankruptcy.
Consol Energy (ticker: CNX) has the balance sheet to survive and even be acquisitive, Young says. The company, which also produces natural gas, has master limited partnership CNX Coal Resources (CNXC) that will also probably withstand the market, Young says. Some energy companies form subsidiary MLPs to run operating assets and pay dividends to shareholders.
Young also says Cloud Peak Energy (CLD), Alliance Resource Partners (ARLP), as well as Westmoreland Coal Co. (WLB) and its MLP Westmoreland Resource Partners (WMLP), should remain intact without declaring bankruptcy.
Young cautions retail investors to wait until companies emerge from bankruptcy before investing and not get into their distressed debt, which can lead to less transparency and liquidity.
But Gartman says investors can buy their debt securities now and then buy their restructured equity once they emerge from bankruptcy.
Investors can also get exposure to the coal space through the Market Vectors Coal exchange-traded fund (KOL), Gartman says, or they can simply create their own basket of coal stocks by buying names in the industry. However, the problem with coal ETFs is that they still contain companies that are distressed and may not be viable over the longer term, Young says.
Gartman likes Peabody Energy Corp. (BTU) and Arch Coal (ACI) because of their coal and mine quality and geographic diversification. Young describes Arch as in extreme distress and says he recently downgraded Peabody to underperform.
There is also a way to play coal via the transportation sector, Gartman says. Canadian Pacific Railway’s (CP) attempt to buy Norfolk Southern (NSC) would be an investment in coal because of Norfolk’s dedication to transporting the commodity.
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Coal Stocks Are a Long-Term Play for Patient Investors originally appeared on usnews.com
