Coal Bankruptcy Fears Stoked, but China Risk Is Bigger (Update 1)

Benchmark met coal prices rebounded from $210/metric ton in the second quarter to $225/mt in the third quarter, according to Haberlin's report. However, prices are now likely headed lower due to increased supply, declining global steel production, and a slower global macro environment, the Davenport analyst wrote in his July 18 earnings outlook. Haberlin recommends buying Peabody Energy shares after he cut its 2012 earnings per share estimate and noted the prospect of a $150 million Patriot Coal-related loss.

Met coal exports within UBS analysts' coverage increased roughly 12% in June and thermal exports were up 287%. Year-to-date, UBS analysts also note that thermal exports are up 16%, with shipments to China and India up 97% and 63%, respectively. Interestingly, it was now-bankrupt Patriot Coal which has led the way with an 86% increase in coal exports, the UBS analysts noted.

In spite of Patriot's July 9 bankruptcy, Raymond James analyst Jim Rollyson has a view of coal stocks that implies bankruptcy is not a legitimate near-term risk for most of the major players and may unduly scare investors off opportunity.

"I think the stocks are factoring in quite a bit lower outlook than we are expecting," Rollyson said. He expects Cloud Peak to come out of earnings relatively unscathed and sees the prospect for optimistic commentary from James River and Alpha Natural Resources that could drive shares higher.

"A lot of balance sheets are more stressed," concedes Rollyson, especially since Alpha Natural Resources and Arch Coal made recent large acquisitions. However, in spite of a weak earnings outlook and high leverage ratios, Rollyson notes that many struggling players have pushed debt maturities past 2012 and 2013 through refinancing. "If you look at the group as a whole, most of these guys don't have meaningful debt due until 2015," says Rollyson.

Rollyson even sees a silver lining for James River -- the company he too highlights as the one with the most bankruptcy risk in the sector: "I suspect they have more staying power than people think."

Following Patriot Coal's July 9 bankruptcy filing, BMO Capital Markets analyst Meredith Bandy cut the ratings of many coal sector players, while highlighting that not all operators and basins can't be judged equally.

In fact, as analysts expect thermal coal to rebound, stock performance will be dependent on the basins to which thermal coal players are exposed.

"The Powder River Basin, with some of the largest surface mines in the world, has economies of scale to compete with natural gas below US$3.00/mmBtu," noted Bandy in a July 16 note that highlighted Cloud Peak, Peabody Energy and Teck Resources as thermal coal-exposed players with the balance sheets, margins and valuations to withstand sector headwinds.

"The Appalachian basin is an aging basin facing rising strip ratios, deeper and thinner seam mines and a rising cost structure. Appalachia needs above US$4.00/mmBtu natural gas prices to compete," wrote Bandy, who downgraded regional giants like Arch Coal and Alpha Natural Resources to underperform on falling margins and stretched balance sheets. "Expected closures in Appalachia may also make servicing debt increasingly difficult," Bandy cautioned.

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