Coal Getting Some Respect

Jim Brown
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The coal sector found some love today after several brokers upgraded coal stocks and a Walter Energy shareholder expressed interest in selling the company. Suddenly the grimy energy stepchild is being let back into the room.

Audley Capital Advisors, a 1.5% shareholder in Walter Energy (WLT) urged the company to put itself up for sale after the recent resignation of the CEO. Audley said it had already spoken to parties who indicated an interest in a partial or outright acquisition of the $7 billion company.

Walter is the largest metallurgical coal miner in the USA. The CEO, Keith Calder, resigned in June after only three months in the job. Calder was the CEO of Western Coal and Walter acquired Western in April. Walter is also suffering from the lack of a permanent CFO. As a growing force to be reckoned with in the coal sector Walter is seen as weakened by the vacancies in the C suite.

There are some aggressive players in the coal sector with Peabody the largest but maybe not the most aggressive. However, Peabody and Arcelor Mittal just offered to buy Macarthur Coal for $5 billion.

Peabody would probably love to own Walter but getting that done would require a major workout with the FTC because Peabody is the largest steam coal miner and Walter the largest metallurgical miner. Having those two combine would definitely be an antitrust issue.

That leaves a small list of potential acquirers. Teck Resources, market cap of $30 billion, Cliff's Natural Resources, $14 billion, and BHP Billiton, $144 billion, as the most likely. BHP has been sniffing around at resource assets in North America for a couple years with an offer to buy Potash (POT) that was turned down and an offer for Petrohawk (HK) last week that was accepted. If BHP could get a foothold in the U.S. coal space that would open the door for Peabody to make another acquisition since it would no longer be the king of coal in the USA.

To put things in perspective the $5 billion offer for Macarthur would value Walter at around $240 per share. It closed Monday at $118. However, Macarthur, an Australian company, has something else going for it and that is its close proximity to China. Citi immediately initiated a buy rating on Walter with a $144 price target. Citi lowered its target on Arch Coal (ACI) to $32 but upped the stock to a buy from hold. They also upgraded Alliance Holdings (AHGP) to buy from hold with a $56 target.

Peabody's CRO, Gregory Boyce, has been very vocal about the current "coal supercycle" and claims this cycle is still at the early stages and could run for the rest of the decade. More than 94 gigawatts of new power plants are expected to come online this year alone. That will increase global coal demand by 375 million tons per year. If the growth continues at the current pace as Boyce expects that would add over one billion tons of annual demand every three years. He actually expects global demand to increase by a whopping 50% by 2020. Seaborne coal demand is expected to increase by 300-400 million tons by 2015.

Coal was kicked to the curb in the last presidential campaign after candidate Obama threatened to shut down coal fired plants in the U.S. but fortunately that did not come to pass. The U.S. produces nearly 45% of its electrical power from coal and that is not expected to change in the near future. New gas fired plants are being built but coal is here to stay for a long time.

In Asia where EPA rules are less stringent there is a massive amount of new coal-fired plants under construction. China completes 10 new coal plants a month.

With the current cloud over nuclear power there are quite a few countries looking again at coal plants using the newer "clean coal" technologies.

With share of coal miners well off their March highs this would be a good time to pickup a few for your portfolio. The ones with Asian exposure and metallurgical coal components would be my choice.

Jim Brown

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