Will Christmas come in July? (Part 1)
Will there be a coal breakout in summer of 2024 and will it be coking coal or thermal or both? Lets dive deeper...
First of all, if you are a reader, there’s a good chance you are contrarian. If so, keep reading, you are going to like coal.
Bull Case
The coal industry can be divided into two main types, thermal coal (lower grade for power production) and coking coal (burnt as part of steel production). Lets outline a bull case for thermal coal:
It’s banned from ESG investing. That means its hated. That means its cheap.
It is still provides 36% of global baseload energy. The world is in no position to switch baseload to natural gas or solar in the near future.
There several healthy companies that return high dividends.
The Chinese regime appears to be building a supply of commodities. They are a net importer of thermal coal and that would be no exception
Bull case for coking (met) coal:
Its become more favorable for ESG. Even though both met and thermal coals are burnt off, the big thinkers have decided since steel is an essential part of humanities future, the net pollution from steel production is palpable. Or, at least, I think I have that correct. It has had its run lately.
Steel is in short supply globally.
The market is small, but companies have strengthened their balance sheets over the last big inflation push in 2021.
P/Es are low and dividends are generous.
China is stockpiling producer goods and commodities.
5/24 Futures Market (The Primary Market)
Thermal Seaborne (at support)
Thermal coal has been sitting on long term support for several quarters now. Long term price action is clearly in stage 1. If this floor is above the cost curve, then cash flowing companies are attractive here as they will pay dividends while the stage 1 accumulation continues.
Newcastle Forward Pricing
Companies are likely contracting months out. This means the likely are realizing 50% higher prices than spot so long as the forward curve stays in the current form. The level of research it takes to determine these prices is at a company level and beyond the scope of this article.
Met/Coking Coal (Neutral)
Unfortunately there isn’t a chart for US markets when it comes to coking coal. The contracts are region and quality based. According to US coal expert Matt Warder, the input costs are roughly $200/tn. I’m inclined to be fairly tepid toward acquiring Met companies based on this chart alone.
5/24 Equity Market (The Secondary Market)
Thermals
Whitehaven (WHC.AX, WHITF.OTC) - Technicals (Neutral to slight bullish)
The chart is moderately bullish if not a bit early. The triangle outlined below looks to be a bull flag for a larger move eventually.
Whitehaven (WHC.AX, WHITF.OTC) - Yield: 6.24% - Fundamentals (Neutral)
Assuming a forward free cash flow of 400m and production life ending over the next 15 years (conservative), the company is fairly priced (US OTC presented). They really need a bit higher prices to realize more cash. Buying this stock at this level would be speculation on higher thermal prices. The most prudent thing at this point is to WAIT for summer to play out and see if thermal prices break to the upside. Then the stock will be a solid buy. The chart target suggested above is reflective of about $900m annual free cash flow in USD.
Yancoal (YAL.AX, YACAF.OTC) - Technicals (Bullish)
This chart looks particularly attractive to a trader alone. There is a clear breakout with clean stops and targets (a +100% move looks possible). Targets of $12 Ausie and stop of $4.50.
Yancoal (YAL.AX, YACAF.OTC) - Yield 10.78% - Fundamentals (Bullish)
Yancoal clears plenty of cash at current prices. Assuming a 15 year terminal life, 9.5% discount and 1B USD annual cash flow, we get a price of $8. The yield is to boot! It seems this stock is a buy if the primary thermal market is in stage 1 or two. I am currently accumulating. BUY with cation.
New Hope Group (NHC.AX, NHPEF.OTC) - Technicals (Neutral)
The conclusion of the chart is to WAIT for a breakout.
New Hope Group (NHC.AX, NHPEF.OTC) - Yield 7.65% - Fundamentals (Slightly Bullish)
NHC is currently priced at 250-300m annual FCF. This is a level they should be able to maintain as long as thermal prices stay above support. In the same way, they should maintain the 50% payout ratio as a floor. This floor is roughly equal to 5-6% yield to shareholder at this price. For the sake of this analysis, we use 300m free cash flow, 11% discount and 15 year life span as a highly conservative assumptions. The valuation should be seen as a floor.
Conclusion: I plan to start accumulating here. As long as the primary thermal index stays in stage 1, I will be compensated for my patience. BUY with cation.
Terracom (TER.AX) - Technicals (Bearish)
The long term fundamentals of TER are very bullish but its advisable to really understand the accounting of a company of very small size. They do produce 2.2 tn tons of thermal coal. That alone should be very profitable, but there is a lot of noise in the accounting.
Conclusion: WAIT for the chart to confirm.
Alliance Resource Partners (ARLP) - Technicals (Bullish!)
Great pattern here! With payout ratio of 60% and 10%+ dividends, this stock should be good to own so long as the thermal charts hold on to support. Based on technicals this would be a BUY on pullbacks.
Alliance Resource Partners (ARLP) - Fundamentals (Bullish!)
Note: ARLP is a Master Limited Partnership. These securities are best held in after tax brokerage accounts. IRS requires tax reporting on IRA MLP total dividends < $1000 per year.
I’ve adjusted the price valuation to reflect a 300 year over year free cash flow. This a conservative estimate to roughly align with the floor of the thermal chart presented above. You can see that the current price offering is still at a discount to the conservative assumptions of 9.5% WACC and 300m FCF. This is a BUY based on fundamentals (so long as thermal prices stay above support). Keep in mine US ARLP operates in the US and US thermal inventories are healthy. Note: The perpetuity growth forecast was used in this calculation. This isn’t necessarily in line with what you think of in coal, but it projected a 12 year terminal multiple. That’s not unrealistic.
Forecasting a target price
500 FCF suggests a price near $50. This is very much in line with the non greedy target in the chart presented above.
Consol Energy (CEIX) - Technicals (Bullish)
Older folks will remember this company as CNX (often seen on train cars). CNX is now a natural gas brand. The technical chart is bullish, but I’d be hesitant to buy next week. I want to see the candle pullback a bit (possibly to the 30 week moving average) on smaller time frames or break above the “blue sky line”. Consol doesn’t pay big dividends, so it helps to let the chart show us best value entries. WAIT for pullbacks or break out. EG. The chart below (weekly) is likely to form a cup and handle look prior to its breakout. A pullback of the handle to 30wma or roughly the $95-98 range should be expected over the next month.
Consol Energy (CEIX) - Fundamentals (Bullish)
Consol is cheap on fundamental basis. It’s currently priced for around 250m annual free cash flow. Or put another way, it currently priced for thermal coal demand to end around 2030.
On a fundamental basis, Consol is a BUY - Accumulate with discipline. Putting it together I would get more aggressive when I see better entry points on the charts.
As for the company itself, it does produce coking coal. That makes about 15% or so up of the total.
General thoughts on thermal…
The ASX companies in WHC, YAL and NHC are in many ways the cheapest options available. However, all three charge a $50 transaction fee on the OTC market. So, playing these stocks may not make sense for the small retail investor. Interactive Brokers will allow access to the ASX for very small commissions.
Met/Coking Coal (to be continued in part 2…)
At a glace, met coal companies like HCC have had quite a run and are due for some cooling. I think the best current opportunities are in thermal at the moment.
The “Beta” Alternative
Range ETF ticker COAL: https://rangeetfs.com/coal
Technically, this is a very new fund. But, at the time of this writing has gotten above very short term support.
Holdings:
Pros: Simple. Fairly pure play. Should pay a nice yield. Wide mix of companies not available on the US exchanges. It’s likely this vehicle could be a great option for those looking for Australian exposure without having to pay high transaction fees or open an account that allows access to the ASX.
Cons: Difficult to segment Met and Thermal exposure. The ETF is new, so the chart isn’t much use on high time frame. You must gauge overall market breadth.
Footnote: If you like this post, follow Matt Warder @mfwarder. This video, where he breaks out a bloomberg terminal, is much watch: https://www.youtube.com/watch?v=ulFplSNWq_Q
Spectacular post Robert. Thanks for the hard work you put into this kind of thing.