Equity research firm Sterne Agee published an Industry Report focusing on the coal sector on Tuesday, September 23rd. SA analysts Michael S. Dudas and Satyadeep Jain argue that coal prices are likely to remain at current low levels and even drop further before bottoming out and moving up into 2015.

Coal Producers

That said, they say the bearish sentiment on the coal producers sector is overblown: “While pricing attempts to bottom, user inventories remain modest and natural gas prices could further aid inventory draws. Generally, companies have been successful in squeezing cost and capital profiles while enhancing overall liquidity and recapitalizing liabilities. Recent sentiment appears overly pessimistic. We continue to support CONSOL Energy Inc. (NYSE:CNX)/Peabody Energy Corporation (NYSE:BTU) among large caps and Arch Coal Inc (NYSE:ACI)/Alpha Natural Resources, Inc. (NYSE:ANR) among small caps.”

U.S. domestic demand hurting coal producers

Coal Producers

The Sterne Agee report projects a 10-15 million tons (1.5-2.0%) increase in U.S. thermal coal demand through 2014. compared to an earlier projection of 30-35 MT (3.5-4.0%). The SA analysts also note rail service issues have remained a bottleneck throughout the summer. Most Western railroads are hiring crews and adding locomotives and boxcars, but the investment is likely to some time to be realized.

Reducing forward coal price estimates

Coal Producers

Dudas and Jain lowered their fourth quarter 2014 met coal price estimate from $135/t to $120/t, and in 2015 from $155/t to $145/t. They also initiated a 2016 estimate of $160/t. The met coal pricing expectations for 2014-15 account for the current surplus in the market and are below estimated normalized levels. Of note, the SA report also highlights that more than one-half of seaborne met coal operates at a loss given current $120 per ton rice levels.

Producers are, however, taking actions to reduce output, which should help work off close to 25 MT of the excess.

Also reducing earnings estimates

Coal Producers

Dudas and Jain say they have been “impressed with the capital and cost discipline shown by coal producers.”

Nonetheless, Sterne Agee reduced their price targets on Peabody Energy Corporation (NYSE:BTU) and Alpha Natural Resources, Inc. (NYSE:ANR) to $25 and $8 from $30 and $10, respectively. The analysts note that the coal companies in our coverage have enough liquidity to survive the downturn, and most will be in strong positions when the market rebounds over the next few quarters.

In closing, Dudas and Jain say they continue to “suggest CONSOL Energy Inc. (NYSE:CNX) and Arch Coal Inc (NYSE:ACI), while Peabody and Alpha should benefit not only from better U.S. thermal, but from global economic recovery trends.”

Coal Producers