EPA Restricts Coal Consumption, But Investors Shouldn’t Shy Away from Sector

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Investors have essentially shunned coal stocks this year. The Market Vector Coal Miner ETF (NYSEARCA:KOL) is down over 3 percent versus the S&P 500, which is up 5 percent. Furthermore, some of America’s biggest coal producers have seen worse performances:

  • Peabody Energy (NYSE:BTU), America’s largest coal producer, is down 15 percent.
  • Arch Coal (NYSE:ACI) is down 20 percent and has made a new low for the coal bear market.
  • Walter Energy (NYSE:WLT) is down a whopping 70 percent!

However, the real loser in the coal sector this year has been James River Coal, which filed for bankruptcy. To add insult to injury, we learned last week that the Environmental Protection Agency has released a plan whereby coal consumption in the United States is going to decline by 30 percent by 2030 in order to reduce greenhouse gas emissions. This has sent shares of many of these companies tumbling.

But while one’s first instinct is to simply get out of coal-producing stocks, I think we need to take a more overarching view of the situation. Coal, as a source of energy in the United States, is not going anywhere. Seventy percent of the electricity in the U. S. comes from coal, and even if politicians want to eliminate coal-generated power completely, they couldn’t do so overnight. The EPA is proposing a 30 percent reduction in coal-based carbon emission by 2030, and given the government’s history of enacting policies, in all likelihood, this is a pipe dream.

With that being the case, I think investors need to consider a couple of options for their portfolios. The first is that they should own some of these down-and-out coal stocks. But you need to be choosy. One coal stock that I like is Alliance Resource Partners LP (NASDAQ:ARLP). This company operates coal mines that are located close to their customers, which eliminates shipping costs. The company also operates some of the lowest-cost coal mines in the industry. As a result, the company is comfortably profitable. It pays a 5.6 percent dividend, which is raised every quarter. Finally, shares are up nearly 25 percent year to date, and that is after the stock fell on the aforementioned EPA news. The stock trades at just under 12 times earnings, and I think it is a must-own for your portfolio.

Another option is Peabody Energy. As we saw above, the stock is down, but at the same time it has failed to make a low exceeding the level hit last summer. If you look at the price performance, it appears as though the stock is making a bottom. Furthermore, the company’s financials are far better than many of its competitors, and it has lower production costs. If coal prices remain low and if sentiment in the industry remains weak, then Peabody Coal will suffer. But if there is a catastrophe in the industry that wipes out a whole bunch of producers, then Peabody Coal will be left standing. On the other hand, if the market improves, Peabody will be well positioned. The stock is trading at about 20 percent of its all-time high, and so if coal comes back into favor, even in a small way, then Peabody shareholders will realize big gains.

A third option is to consider Chinese coal producers. There are a lot of them, including a couple that trade in the U.S. markets. Before moving on, I should note that coal markets are highly localized, unlike, for instance, the gold market, which is global. That’s because it is inexpensive to ship a large value-amount of gold, whereas it is expensive to ship even a small amount of coal because it is so cheap in comparison. So actions in the United States will have a minimal impact on coal markets overseas. With that being said, the Chinese have rising coal demand. While they have rising levels of pollution, their government can’t restrict coal burning without halting the economy.

With that being the case, Chinese coal demand will remain robust, and Chinese coal producers will benefit. One company to consider is Yanzhou Coal Mining (NYSE:YZC). The stock is down 13 percent for the year, but it appears to have made a bottom in March, and it is in what appears to be a new uptrend. The stock trades at just $8 per share and once traded at $40 per share, so there is a lot of upside potential here. Furthermore, the company made a profit last year, whereas its American counterparts did not (with Alliance Resource Partners LP as an exception). The company is growing production, and even if coal prices stabilize or rise modestly, Yanzhou shares will perform extremely well.

Disclosure: Ben Kramer-Miller is long Alliance Resource Partners LP.

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