Long Term Bull SuperCycle For Coal ?
Every year the world adds more people and more of those people are joining the middle class. The result is an obvious increase in consumption of resources. These are two trends that are not going to stop and therefore we as investors should think carefully how to invest in a world of shrinking resources.
Did you know that the consumption of coal is growing faster than the consumption of both natural gas and oil ?
Consider the following note from Jeff Saut of Raymond James
“Change of a long-term or secular nature is usually gradual enough that it is obscured by the noise caused by short-term volatility. By the time secular trends are even acknowledged by the majority they are generally obvious and mature. In the early stages of a new secular paradigm, therefore, most are conditioned to hear only the short-term noise they have been conditioned to respond to by the prior existing secular condition. Moreover, in a shift of secular or long-term significance, the markets will be adapting to a new set of rules while most market participants will still be playing by the old rules.
I was reminded of the bullish potential for coal while listening to arguably the best energy portfolio manager on the planet, namely BlackRock’s Dan Rice. To paraphrase his comments, Dan suggested that with 2% world GDP growth the price of crude oil would average $80-$85 per barrel. That should allow oil stocks to rise by some 40% over the next few years. He also stated that we're living hand-to-mouth on many commodities like oil, copper, and coal. The comments that really struck me were about coal, which he said would rise from a price of $60-$65 per ton to $85 per ton with a concurrent 300% “hop” in the aggregate share price of many coal stocks.
My interest piqued by Dan’s comments, I reflected on a presentation by Peabody Energy’s (BTU) CEO, Gregory Boyce, and his belief regarding the “long-term supercycle for coal.” In said presentation, Mr. Boyce observed that coal has been the world’s fastest-growing fuel over the past decade, with demand surging by nearly twice the rate of natural gas, and four times faster than global crude oil consumption. “It’s stunning,” he said, “that any mature commodity could expand some 50% in a decade.” He went on to say, “coal (usage) is expected to grow faster than other fuels in the coming decade.” Indeed, in 2010 more than 94 gigawatts of new coal-fired electric generation facilities are slated to come online, representing roughly 375 million more tonnes of coal consumption. This comes at a time when the burgeoning middle class of emerging countries is demanding more electricity, as well as more steel, both of which compound the demand for coal! Peabody estimates the demand for coal will increase by ~1 billion tonnes over the next four to five years. Currently, Peabody is exporting 6-7 million tonnes of coal per year, but intends to ramp that production to 20 million tonnes over the next few years.
While there are many favorably rated coal stocks in our research universe, there's only one Strong Buy-rated name: Alpha Natural Resources (ANR). Conveniently, Alpha had an Analyst Day last week, causing our analyst, Jim Rollyson, to pen the following research note:
On Tuesday, we attended Alpha's Analyst Day in Pittsburgh. Overall, there weren't any earth-shattering revelations. We did, however, come away with several takeaways. The recent Foundation Coal merger is working out better than planned. The balance sheet remains in a strong position with Alpha's net debt position continuing to slide. At the end of the second quarter, net debt stood at $159 million (including nearly $662 million in cash and marketable securities). The good news is this exceptional balance sheet leaves Alpha with many opportunities to invest in organic growth projects and/or M&A potential.
M&A moves are a matter of when, not if. Alpha has made it known it is looking at acquisition opportunities both domestically and abroad. Additionally, several organic growth projects are in the works. Alpha highlighted several new mine projects under development, or in the permitting stage, anticipated to at least replace production over the next several years and in certain cases enhance it. Finally, valuation remains attractive, especially for a larger cap, diversified coal producer. Touting a cheap valuation has become a normal character trait for Analyst Days, but in this case we have to agree. After successfully completing the Foundation merger, putting up decent results for several quarters (even through the global recession) and continuing to improve the balance sheet, ANR trades not only below the larger, diversified peers it compares itself to, but at a discount to the overall group as well. Our model suggests ANR trades for ~4.5x 2011 EBITDA as compared to 5.6x for the larger peers, which if normalized would drive ANR share price into the low $50s. Note that this excludes any separate value for ANR’s natural gas assets, which we believe could offer another $5-10/share of future potential upside.”
I’ve linked below the presentation by Boyce that was referred to above. It certainly makes for interesting reading, although the source is certainly biased.
Peabody Energy Presentation
I still favor oil and fertilizer related commodities, but the argument for many others is compelling.