Time to Buy Coal Stocks?

 | Jan 14, 2013 | 1:30 PM EST  | Comments
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Stock quotes in this article:

btu

,

cnx

,

aci

Last week the two coal stocks in the Standard & Poor's 500 Index, Peabody Energy (BTU) and Consol Energy (CNX) were both among the five-worst performers in the index.

Contrarians like me have to wonder if it's time to buy coal.

Some people, doubtless, would say the right time is never. Natural gas is too plentiful and cheap, they say, and coal is too dirty. Coal can't win and has no future.

Other people would say the time to buy is now. Peabody, for example, sells for about 1.1x book value (corporate net worth per share), compared to a ten-year average near 3. Peabody shares go for about $25, compared with a high of almost $85 in mid-2008.

My own view is that the time to buy is not yet, but coming soon. Coal use, while declining in the U.S., is growing in most other countries. So, U.S. coal companies should be able to increase their exports over the next few years. They should also regain some market share from natural gas for power generation here in the U.S., as the worst of the gas glut is over.

For me, the biggest obstacle to investing in coal companies is their ugly balance sheets. I usually prefer to buy stocks of companies whose debt is less than 50% of stockholders' equity. As the table below shows it's hard, maybe impossible, to find that among coal producers. Most coal companies operate with a lot of debt, especially after the last few years, when cheap gas made life for coal companies miserable. 

Here's a quick look at valuations and debt-equity ratios for a handful of coal producers.

 

Another thing to worry about with some coal companies is their obligation to pay for healthcare for retired workers. This sounds a lot like the problem auto and steel companies had a few years ago. 

With stocks whose earnings are volatile from year to year, I sometimes focus on what I call the malt shop P/E ratio. This is the stock's current price divided by the third-best annual earnings in the past 10 years. With Arch Coal (ACI), for example, the malt shop P/E is only six, even though the P/E on trailing earnings is 46.

Even for fundamental value investors, there's some feel involved in finding the right time to buy. I'm looking over the coal stocks now and may choose to pull the trigger in the next month or two.

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