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Mr. Bowman is a portfolio manager at Hamilton-based Wickham Investment Counsel Inc., an adviser to high net worth clients. michael@wickhaminvestments.com
What are we looking for?
Concerns about global warming have raised many questions about the long-term potential of investing in coal stocks. Companies are being pressured to find alternative sources to this comparatively dirty energy, but new technologies and discoveries are proving that burning coal remains one of the most practical ways to fuel our energy demands. This week, my colleague Sean Pugliese and I are taking a closer look at thermal and metallurgical coal companies.
The screen
We isolated corporations trading in North America that are larger than $200-million in market capitalization, and we have indicated whether they produce metallurgical or thermal coal, or both. Metallurgical coal is used in steel making and thermal coal is used by utility companies to generate electricity.
The EV/EBITDA (enterprise value divided by earnings before interest, taxes, depreciation and amortization) metric makes it easier to see what price investors are paying for cash flow. Stocks with lower numbers are less expensive.
Many coal companies are highly leveraged, which can be a two-edged sword. If coal rebounds, debt can be a good thing, but if there is still downside to the black rock, leverage could spell trouble. Again, we are looking for a low number in the Debt/MC (debt to market capitalization) ratio.
What did we find?
We have included Teck Resources in our screen. The company is one of the largest coal producers in North America but its base metal component makes it more diversified than its peers. The Vancouver-based miner ranks in the top half (that is, among the lower numbers) of our two key metrics.
Peabody Energy has a debt-to-market-capitalization ratio of 108 per cent, indicating the company is highly leveraged, but it still pales in comparison to St. Louis-based Arch Coal's 443 per cent.
Investors could consider those companies that are below the average in the EV/EBITDA and Debt/MC metrics such as Cloud Peak, Alliance Holdings, Suncoke, Rhino Resources, Hallador and Teck.
Conclusion
Thermal coal has dipped about 30 per cent in the past 12 months. Since natural gas prices have risen, and may continue to do so, it could make sense for utility companies to switch back to coal to generate electricity.
Metallurgical coal has slid about 50 per cent in the past year but has jumped 6 per cent in 2013 in anticipation of an improving Chinese economy, and an imbalance in the supply-demand equation.
While this may be the time to jump in, investors need to realize these are not blue-chip companies, and they will remain risky and volatile.