Bargain Hunting for Coal Stocks

by Sihien Goh, Kapitall staff writer

Coal prices have tumbled in the last two years and stock prices of coal producers have fell correspondingly. For the last twelve months, major coal producers such as Peabody Energy Corporation (BTU) and Alpha Natural Resources (ANR) have seen their stock prices fall 35% and 61% respectively. Are coal shares near their bottom? This article takes a brief look at two coal companies.

At US$6.86 billion, Peabody Energy’s market value is trading close to the low it reached during the financial crisis. Referring to the table below, the average free cash flow (FCF) for Peabody in the last three years is around US$520 million. That translate to a roughly 7.5% average FCF yield for this coal company and an 8.6% FCF yield for FY 2011. At this valuation, the company looks like a potential value play.

Both Peabody Energy and Alpha Natural Resources made acquisitions during coal’s boom cycle between late 2010 to mid-2011 and since then have been struggling to recover to their pre-acquisition prowess. Peabody Energy acquired Macarthur Coal in August 2011 for US$5.2 billion and its consistent FCF yield speaks volumes of its progress so far. Unluckily for shareholders of Alpha Natural Resources, its acquisition of Massey Energy in June 2011 has not brought a similarly smooth transition.

FCF for Alpha dipped into the negative last fiscal year as it struggles to fully absorb Massey Energy. An outflow of US$282 million was recorded and its three year FCF average is around US$50 million. Compared to Peabody Energy, Alpha Natural Resources’ ability to generate cash seems pretty weak with an average three year FCF yield of only 2.5%.