August 6, 2018 - The fossil fuel Coal play an integral role in meeting the ever-increasing global energy demand thanks to rapid urbanization and modernization. Since coal can be found in small quantities in almost all countries across globe with recoverable reserves in nearly 70 countries, it is an automatic choice of energy source.
Despite concerns over air pollution due to usage of coal, its wide availability and low prices compared with other conventional and alternate fuel energy sources makes it a preferred choice of fuel in most nations.
As per a World Coal Association report, 37% of world electricity and 74% of world steel production depends on coal. The current estimated 1.1 trillion tons of proven coal reserves across globe and this fossil fuel can last nearly 150 years at current rates of production.
Since coal reserves will last much more than oil and natural gas reserves, initiatives have been taken across the globe to utilize coal more efficiently, keeping a check on emission levels.
According to a Reuters report, overall capital spending in U.S. coal industry has increased by nearly 27% in 2017. This is a positive development for the coal industry as in the past few years, coal operators were drastically cutting expenses to survive difficult times.
The pro-coal stance of the new administration, rising coal exports to Asian countries and retrofitting as well as upgrading of domestic coal plants are creating fresh demand in the coal industry.
Industry Outperformed S&P 500 Returns
The Zacks Coal Industry, which is an 14-stock group within the broader Zacks Oil – Energy sector, has outperformed both the S&P 500 and its own sector over the past year.
While the stocks in this industry have collectively gained 25.2%, the Zacks S&P 500 Composite and Zacks Oil-Energy Sector have rallied 14.4% and 16.0%, respectively.
Coal Industry Stocks Trading Cheap
Since coal companies have a lot of debt on their balance sheets, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive coal companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structure and ignores the effect of noncash expenses.
Despite the industry outperformance over the past year, the valuation appears cheap, in comparison to the market at large. The industry currently has a trailing 12-month EV/EBITDA ratio of 4.2, which is above the median level of 3.92.
The trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.77 and the median level is 11.43.
Since the S&P 500 has the best companies under the universe it is quite natural that its valuation appears pricey compared with the coal industry. It will assure investors that the coal industry is currently trading at a decent discount to the broader sector. The Zacks Oil-Energy Sector’s trailing 12-month EV/EBITDA ratio of 6.7 and the median level of 6.6 for the same period are above the Zacks Coal Industry’s respective ratios.
The coal industry has gradually rebounded on favorable steps taken by the new U.S. administration, coupled with rising international thermal coal demand. The gradual recovery in metallurgical coal prices is also having an impact on the prospects of the coal industry. New coal mines have opened in the United States to cater to rising demand in domestic and international markets.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The valuation analysis above shows that the coal industry is presently trading cheaper than the broader sector and the Zacks S&P 500 composite, and currently has bright prospects despite concerns on pollution.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance is its earnings outlook. Empirical research shows that the earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Zacks Coal industry
The current consensus earnings estimate for the Zacks Coal stock industry of $2.02 per share implies a substantial year-over-year improvement, as the trend in earnings estimate revisions has been favorable. Looking at the aggregate earnings estimate revisions, it appears that analysts are regaining confidence in this group’s earnings potential.
The consensus EPS estimate for the current year has been revised upward by 8.6% since Jun 30, 2018.
Zacks Industry Rank Indicates Rosy Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.
The Zacks Coal industry currently carries a Zacks Industry Rank #114, which places it at the top 45% of more than 255 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Coal Stocks Promise Long – Term Growth
We could also notice a recovery in the top line of coal stocks since the end of first quarter of 2016 and that the upward movement is still on.
To Sum Up
Coal has its shortcomings but it has undeniably been the main source of energy for more than hundred years. The commodity still holds an important place in the energy mix.
The coal industry has already seen its share of difficulties, with dropping demand, rising competition from other energy sources and increasing emission awareness taking a toll on the industry for past few years.
However, things have started to change for the better for this mature energy industry, the improvement in thermal coal demand in global market, better demand for met coal in steel industries and improving met coal prices are having a positive impact on its prospects. These positive factors make coal industry a sound investment option.
At present only one stock in our coal industry universe, namely Peabody Energy, holds a Zacks Rank #1 (Strong Buy). Below are two stocks from the same space that have been witnessing positive earnings estimate revisions and carry a Zacks Rank #2 (Buy).
The consensus EPS estimate for St. Louis, MO based Peabody Energy has moved 27.9% higher for the current year, over the last 60 days. The stock has gained 40.0% over the past year.
Brookwood, AL, based Warrior Met Coal, Inc.’s consensus EPS estimates has moved 10.1% higher for the current year, over the last 60 days. The stock has gained 21.5% over the past year.