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Is Coal Back From the Dead?
 Old King Coal isn't dead yet. And there's at least one bargain begging to be scooped up by shrewd investors.
I have firsthand experience with coal. I shoveled at least a half-ton of the black rock per trip when I was a fireman on the Cog railroad that climbs up Mount Washington in New Hampshire.
Depending on the crankiness of the old steam engine, sometimes it was three-quarters of a ton. Three times a day. Uphill! On my way to school.
Okay, it wasn't on my way to school. But the rest is true. We'd come off the engine at the end of the day completely covered in coal dust and thick grease. Good times, good times.
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Why People Are So Down on Coal
Many think the good times are over for coal. It is the dirtiest way to make energy, and the Chinese, who consume 49% of the world's coal, are sick of choking on the air they breathe. And it's not just China giving the resource up. Around the world, coal-fired power plants are being replaced by natural gas plants and solar arrays.
Here in the U.S. alone, the Energy Information Administration expects a 7% decline in coal use just this year. U.S. coal prices dropped more than 40% since 2011. Coal used to generate half of America's electric power. Now, it's down to 36%.
That's why coal-mining stocks have plunged. Many trade below book value. And by my count, at least four major coal companies - including Patriot Coal, James River Coal, Walter Energy and Alpha Natural Resources - have delisted or filed for bankruptcy.
Maybe, in the long run, coal will go the way of the dinosaurs from which it is made. But in the short term, I see an opportunity for investors. There is way too much pessimism in this sector. And that means plenty of opportunity is waiting to be grabbed.
Here are three reasons why coal ain't dead yet...
Opportunity No. 1: India Goes Boom!
Sure, coal use in China may be plateauing. This is not the case in India. India currently uses 10% of the world's coal. By the end of this decade, India will become the world's second-largest user of coal. And by 2040, its coal capacity is expected to double.
In fact, coal use is rising across Asia as a whole. The new coal-fired capacity coming online between now and 2040 in India and other emerging Southeast Asian countries is nearly double all the existing capacity in the U.S. today.
In fact, Asia is expected to use more energy of all sorts - everything from hydro, oil and gas to nuclear, renewables and coal. According to financial research group Macquarie, total fossil fuel demand in Asia is expected to rise to the equivalent of "three times Saudi Arabia's current (all-time-high) oil production."
Why is India building so much coal capacity? Well, India is growing its industrial capacity. And that's how you traditionally fire industrial growth, because industry needs a reliable, cheap power supply. Coal is reliable and remarkably cheap.
Opportunity No. 2: The Death of Coal in China Is Greatly Overstated
Sure, Chinese coal use is dropping. Here are the stats that scare the coal market…
China's "implied coal demand" - the sum of production and net imports - has fallen by 10% in the past year.
Every month since August 2014 has seen China's coal demand decline further – that's 12 months in a row.
In August, China imported 17% less coal than it did a year earlier. And year-to-date, imports are down 31%.
That's why everyone gets so scared. Those numbers look brutal for coal's future. However, here's what most people don't realize.
- Imported coal is more expensive now. China's currency is still pegged to the U.S. dollar, despite a 3% devaluation. Imported coal is so costly that when China can source locally, it does.
- There are many ways to measure coal usage. Measuring total tons used, China's coal use has dropped only 6% year over year, not 10%.
- This decrease in China's coal use may happen even more slowly going forward. In fact, Macquarie estimates that coal will still be the dominant source of energy for China.
Sure, we'll see more renewables used in China. But coal and other fossil fuels aren't going away. Not by a long shot.
Opportunity No. 3: Europe Is Building New Coal Plants, Too
America likes to caricature Europe as the home of Brie-eating, girly men who place environment over business. And sure, coal's share of power generation dropped a bit, from 29% to 27% between 2005 and 2013. Also, total coal use is down 15% in Europe since 2005. But total electricity use is going down in Europe, too.
But check out the new power plant one company is building in the Netherlands.
German energy giant RWE is building a 1.6 gigawatt coal-fired power plant at Eemshaven in the Netherlands. Once it throws the switch, this plant will generate enough electricity for 2 million German and Dutch homes.
That's more homes than all the homes powered by solar in America.
In fact, use of coal in the power sector increased by 30% in the Netherlands during 2015. This might have something to do with the bad press coal plants get in Germany. But Germany still needs power. So, building a plant in the Netherlands avoids a lot of bad publicity.
Now, the Eemshaven plant will be enormously efficient, with an efficiency of more than 46%. The average efficiency of fossil-fueled power plants in the United States is 33%. If Europe can build more plants like the one in Eemshaven, it will be able to generate a lot more power from less coal.
Big Money Is Looking at Coal Again
Recently, billionaire investor George Soros bought more than 1 million shares of Peabody Energy, the world's largest private coal company, and 500,000 shares of Arch Coal.
But if you're going to buy a coal miner, consider Alliance Resource Partners L.P. (Nasdaq: ARLP). I recommended this stock as an extreme value pick at the Sprott-Stansberry Natural Resource Symposium in Vancouver on July 30.
You can see Alliance has put in a bottom and broken its downtrend. And fundamentally, Alliance is a company with a lot going for it.
- It grew its profits for 14 consecutive years! Profits will dip this year, and may be under pressure next year. But it has plenty of cash flow.
- It can produce coal at a much lower cost than many of its peers.
- It trades at just 6.2 times earnings and 0.79 times sales.
- It has just $873 million in net debt and $761 million in trailing 12-month operating free cash flow.
- Finally, its big fat dividend of 10.9% is expected to grow 7.1% per year for the next three years.
I think Alliance is the veritable diamond in the dustbin.
Investing in coal companies isn't for everybody. Do your own due diligence before buying anything.
All the best,
Sean
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