Our near-term (6-18 months) outlook for the coal industry has improved somewhat from our previous neutral sentiment to a more positive undertone. Based off of various recent economic indicators, the U.S. economy appears to be stabilizing. Although the rest of 2009 is likely to continue on a path of weak steel and electricity demand relative to 2008 levels, several factors should help lift the coal producers in 2010.
Reductions in capex spending from both coal and natural gas producers, the weakening of the U.S. dollar and most importantly, increased steel and electricity consumption in '10 should all be positive catalysts for the coal industry next year.
As stated in earlier outlook summaries, benchmark metallurgical prices for fiscal 2009 have been set around $120/mt -- off markedly from the $300/mt level seen in 2008 but still above historical met price levels. This means that in 2010, producers will still realize triple digit average prices for met coal.
This also represents a more long-term indication of what the implied floor for metallurgical coal prices are due to the perfect storm of negative economic data that pervaded the global markets during pricing for this year.
OPPORTUNITIES
The larger coal players with strong balance sheets will be able to capitalize on the current market environment in the form of acquisitions. With asset prices coming down from mid-'08 levels and smaller producers feeling the strain on margins, this represents opportunities to acquire reserves on the cheap.
In particular, we like companies with exposure to the international coal markets as well as the
Powder River Basin (PRB) in the U.S. Companies like
Peabody Coal (
BTU) and
Arch Coal Inc. (
ACI) look attractive currently. Both have recently engaged in long-term growth acquisitions.
Peabody is the largest pure-play coal producer, with significant leverage to the Australian export market. Due to the high quality of coal produced and its proximity to Asia (emerging markets) Australian seaborne coal trades at a premium to all other coals.
Peabody would benefit especially when China and other Asian emerging markets begin to rebound. The stimulus packages enacted by the federal government during the recent months should start to pay dividends toward the end of '09.
Arch Coal has a significant amount of reserves and is a top-three producer in the PRB. In our opinion, PRB coal will be in great demand over the coming years. The significant coal-fired power plant build-out will increase annual thermal coal demand by more than 60 MM tons; approximately 50% of this new demand will be met by PRB supply.
