The Trouble With Massey Energy
Oil prices are at nosebleed levels. Natural gas is soaring. Coal should be following suit, right? Not exactly. Though it has the advantage of domestic production—and is all but certain to remain a crucial resource for the foreseeable future—the mineral has not, of late, rewarded investors at a time when other energy sectors have skyrocketed.
Its strategic importance is clear: The U.S. generates about half of its electricity from coal. With supplies in the ground expected to last at least 100 years, the country has been called the Saudi Arabia of coal.
Maybe that's too much of a good thing. Coal's abundance—which has created a drag on prices for the fuel—is one reason why stocks in the mining industry haven't performed well. Dogged by low prices and overconcentration in a single mining region, Massey Energy (MEE) is a vivid example of the challenges the sector faces in the near term; the company's stock hit a 52-week low of $23.74 on July 28, down from $57 in September.
The stock's latest stumble—though prices have since recovered a bit to close at $26.82 on Aug. 3—came after the company reported disappointing second-quarter earnings of 4 cents per share, down from 48 cents per diluted share one year earlier, and nowhere near Wall Street expectations of 45 cents. The company also said it would discontinue operations at one mine and let four more idle, cutting back on expected production.
Massey is the largest coal mining outfit in Central Appalachia, a region known for dense coal containing relatively little sulfur. It's a miner's dream; the high-quality product reduces transport costs and, when burned, releases less sulfur dioxide, a cause of acid rain.
But the company suffers from its focus on one region. Stifel Nicolaus analyst Paul Forward says that after about a century of mining in West Virginia and Kentucky, "the stuff that's easy to mine is long gone." And those seams accessed through less cost-intensive strip mining procedures tend to yield lower-quality coal than those found underground. (Stifel has an investment banking relationship with Massey.)
"I'm bullish about the coal industry, about where I think we'll be in three to four years," Forward says, as it's expected that more coal-fired power plants will come online, but at the moment he's less enthusiastic. This year, more efficient railroad transportation and mild weather have enabled electric utilities to beef up their stockpiles. As of July 28, NYMEX spot prices for a ton of Central Appalachian Coal were $48.50, down from $58.50 a year before, when Massey shares closed at $44.43.
Forward says more extreme weather and increased overseas demand for metallurgical coal—very high-quality coal used in steelmaking—could boost coal prices. But he is tepid on the stock in the near term, rating it a hold with a $25 fair value.
With few exceptions, he says companies operating in Central Appalachia need prices of more than $50 per ton if they are going to earn a decent return on investments in operations and maintenance. Massey also admits in its 2005 annual report that it has had trouble holding on to skilled labor, a problem Forward attributes primarily to a regional shortage.
BURDEN OF ABUNDANCE.
Morningstar analyst Elizabeth Collins is similarly glum about Massey's stock price, having reduced her fair value to $29 from $43 following second-quarter earnings. She emphasizes that the company faces increasing competition not only from lower-quality but more accessible coal in areas like the western Powder River Basin in Wyoming and Montana, but also from other forms of energy such as natural gas and even nuclear power. Coal could also suffer in the near term from regulations of emissions of greenhouse gas carbon dioxide, an eventuality she says is "on my radar."
Collins says that more geographically diverse competitors like Peabody Energy (BTU), the world's largest private-sector coal company, have advantages over Massey, but as a whole she remains bearish on coal mining groups without a buy among the seven coal outfits she covers (see BusinessWeek.com, 6/13/06, "Coal Hard Cash for Peabody?").
Comparing coal to its fellow fossil fuel, Collins notes that with oil "you have a cartel that can influence the supply of oil and ensure profitability," she says. But in the absence of an anthracitic OPEC, coal's abundance continues to be a boon for the power grid and a problem for the outfits that dig it out of the ground.