Skies Blacken for Coal Stocks

Coal stocks plunged on Wednesday, as investors reacted to the news that both
Alpha Natural Resources (NYSE: ANR ) and Walter Energy (NYSE: WLT ) cut their
output estimates for 2011. Even worse, Walter said third-quarter earnings would
be well below Wall Street's current expectations. While both companies cited
specific production problems, Alpha also included this key phrase – "reduced
metallurgical export shipments to Asia due to unexpectedly curtailed customer
activity levels" – as one of the reasons for its shortfall. China, of
course, has been one of most important drivers of demand for U.S. coal
companies. These latest announcements are just another piece of bad news in a
summer/autumn period that has seen harsh declines in coal stocks. Fears about
slowing global growth have weighed disproportionately on the sector – which is
dependent on the fortunes of both the steel-making and power industries – and
it now it faces the added challenge of further estimate reductions and likely
analyst downgrades. Below are the returns of selected coal names from their
highs of early April through early Wednesday morning: Yanzhou Coal YZC -38.8%
Peabody Energy BTU -43.4% Consol Energy CNX -28.8% Alpha Natural ANR -64.4%
Walter Energy WLT -52.8% Arch Coal ACI -53.8% Patriot Coal PCX -63.7% Some brave
investors may be sniffing around this sector looking for a buying opportunity
here. However, even with the stocks so far off their highs and valuations having
come down so far in recent months, coal shares are in the same boat as most
cylicals at this stage: too low to short, but still too dangerous to buy. First,
like just about every other cyclical right now, the near-term fortunes of coal
stocks remains firmly rooted in the macro trade. And until the fears about the
global economy subside, there is little chance coal shares will be able to
sustain an extended move higher. Any purchase should therefore be viewed as a
short-term trade at this point: buy shares, get your 5%, and get out before the
next wave of bad news hits. Another challenge for coal is the perilous technical
picture. Using the Market Vectors – Coal ETF (NYSE: KOL ) as a proxy, the
sector is just a hair above its 52-week low (set in September, 2010) and is now
trading below its low point of the August selloff. Some individual stocks,
including Walter, Alpha Natural, and James River Coal (NASDAQ: JRCC ) are
already at their 52-week lows. In contrast, the S&P 500 stands about 8.7% above
its August nadir. A look at the KOL chart shows the next support at $30, which
leaves another 14% of potential downside from here. Clearly, coal stocks have
seen little benefit from the rising market, which leaves it extremely vulnerable
if the broader indices begin to weaken once again. The fundamental picture is no
longer particularly compelling, either. Deutsche Bank recently came out with a
report calling for coal output to rise only 2% in 2012. In addition, the U.S.
Energy Information Administration (EIA) released a report earlier this month
that said the following: EIA expects that coal consumption for electricity
generation will decline by 21 million short tons (MMst) (2.1 percent) in 2011,
as total electricity generation rises by 0.4 percent and generation from natural
gas increases by almost 2 percent. EIA forecasts that coal production will fall
by 2.2 percent in 2011 despite a significant increase in coal exports… EIA
expects coal production will remain flat in 2012. Forecast U.S. coal exports
fall back to about 87 MMst in 2012 as supply from other major coal-exporting
countries recovers from disruptions. In total, this is hardly the backdrop for a
screaming buy. As a result, the best strategy now appears to be to wait it out
and let the clouds dissipate. A potential trading opportunity exists in the form
of the upcoming earnings season, when a sell-the-rumor / buy-the-news trade
could work once coal companies begin to report. When that time comes, focus on
companies with good fundamentals – Deutsche cites Arch Coal (NYSE: ACI ) and
Patriot Coal (NYSE: PCX ) in its report – and those with exposure to the
stronger Asian market, such as Yanzhou Coal (NYSE: YZC ). Walter Energy itself,
which was recently rumored to be a buyout candidate, represents a potential
lottery ticket for stout-hearted traders. In the meantime, the story is the
same: as long as macroeconomic issues are the main factor moving stock prices,
be safe and stick with the winners. And right now, coal stocks simply don't
fit the bill.