BTU - Investors Discover CONSOL Energy

2023-09-12 13:34:29 ET

Summary

• CONSOL Energy is a $3 billion market cap US thermal coal company paying a 4.7% dividend.
• Growth in export and non-power markets, like Indian cement, has prompted a stock price run-up.
• CONSOL Energy may interest dividend investors, but capital appreciation investors may want to wait for a lower entry point.

CONSOL Energy ( CEIX ) mines thermal (bituminous) coal in Appalachia but is shifting its markets toward non-power generation sales. Exports are key to the company's revenues.

In 2017, the predecessor company separated out its Appalachian natural gas business, which now trades as CNX Resources ( CNX ).

Pummeled along with other energy companies in 2020, the company's stock price has risen from the single digits since then by a factor of 25-30x.

The company's biggest competitor is not a US company but a country- China - which supplied over 50% of the world's coal in 2022.

Dividend hunters will like the company's stock repurchase program and 4.7% dividend, along with its bargain current and forward price-energy ratios. Moreover, while thermal coal has been thought a declining business, especially in the US, and has been hammered by environmental regulation, there is renewed appreciation for its baseload characteristics in electricity generation. Although utilities have shut many coal plants and continue to do so, a shortage of 24/7 generating capacity in regions like MISO (Mid-continent Independent System Operator) has caused grid operators to take a second look at coal.

And overseas, coal has been part of the solution to the lack of Russian pipeline gas for countries like Germany and Poland.

CONSOL Energy is not unknown: it is now trading near its 52-week high. Investors looking for capital appreciation in energy stocks may want to wait for a lower entry point.

CONSOL Energy's Second Quarter 2023 Results

In the second quarter of 2023 CONSOL Energy's GAAP net income was $167.7 million, or $4.94/share. This compares to $126.3 million for 2Q22. Adjusted EBITDA for 2Q23 was $276 million compared to $216 million for 2Q22.

Cash from operations was $228 million (vs. $198 million in 2Q22) and free cash flow was $181 million (vs. $160 million in 2Q22).

Year-to-date through July 31, 2023, the company repurchased 3.1 million shares of stock at an average price of $60.83/share .

CEO Jimmy Brock noted an interesting shift toward markets beyond power generation in the report, "During the quarter, we continued our strategic sales shift into export and industrial markets, which we believe will provide the best opportunities for our PAMC (Pennsylvania Mining Complex) product moving forward. As such, 78% of our 2Q23 recurring revenues and other income in aggregate came from sales into the export market and 64% in aggregate came from non-power generation sales."

During the quarter, CONSOL produced 6.3 million tons and sold 6.4 million tons, slightly ahead of 2Q22. The average cash margin per ton sold was $44.94 compared to a cash margin of $37.37 for 2Q22.

And last week, CONSOL Energy offered a compelling 3Q23 presentation that shows the need for coal to fill in for LNG and for use by India for cement. The presentation can be accessed here .

Customer Segments

It is particularly useful to see the sources of CONSOL's revenues : more thermal though with growing industrial, and for the first six months of 2023, more export-driven than domestic.

Macro

Although the US has been pushing to shut down thermal coal-generating plants, backlash is occurring due to insufficiency of replacements with the same 24/7 operating characteristics.

As described below, China is building many coal-powered plants. In the EU, countries like Germany and Poland are using coal to replace lost Russian pipeline gas that, prior to the invasion of Ukraine, was 40% of the EU's supply.

Of course, liquefied natural gas is being brought into Europe to replace Russian pipeline gas from many sources, including the US. And, because it is not sanctioned, Russian LNG is also serving the European market.

In the US, government overspending has driven up inflation. The Federal Reserve has responded with increased interest rates. The Federal Funds rate is shown in the chart below.

US Spot Coal Prices

In the US, coal is valued by location, BTU (heat) content, and sulfur content. Supply markets are central Appalachia, northern Appalachia, Illinois basin, Powder River basin (western) and Uinta basin (western). For the week ending September 8, 2023, the northern Appalachian spot coal price (13,000 BTU/lb and less than 3% sulfur dioxide) was $2.08/MMBTU or $54.10/short ton. The central Appalachian spot coal price (12,500 BTU and 1.2% sulfur dioxide) was $2.80/MMBTU or $70.00/short ton.

While CONSOL's coal is sold under contract, the spot price gives a directional indication.

Competitors and Regulation

CONSOL Energy is headquartered in Canonsburg, Pennsylvania.

As a supplier of generating fuel to utilities for 24/7 operations, where allowed, it competes with nuclear and with natural gas. Because it is a high-carbon fuel, US federal and state regulators have been shutting down coal-fired generating plants for several years: natural gas has largely taken its place as the dominant fuel for electricity.

Still, the dislocation of Russian natural gas has caused countries like Germany to increase its usage of coal. And due to its large reserves, China favors growing coal use, with dozens more coal-fired generating plants set to come online: it granted permits for 106 gigawatts of coal-fired electricity across 82 plants in 2022 alone.

In 2022, China was by far the world's largest coal producer, supplying 52.8% of the total. It was distantly followed by India at 8.6%, Indonesia at 8.0%, and the US at 6.9%.

In the US, another large thermal coal producer is Peabody ( BTU ).

While thermal coal is being used in some EU markets as a replacement generating fuel for lost Russian pipeline gas, coal also competes in these markets with new and growing liquefied natural gas imports.

Other companies in the US and abroad supply metallurgical coal, used to make steel.

Governance

At September 1, 2023, Institutional Shareholder Services ranks CONSOL Energy's overall governance as a good 3, with sub-scores of audit (7), board (2), shareholder rights (4), and compensation (3). On the ISS scale, 1 represents lower governance risk and 10 represents higher governance risk.

Insiders own 2.6% of the stock. Shorted stock as a percentage of float is 11.4%.

CONSOL Energy's beta is 1.85. This is much more volatile than the overall market, but not unlike betas for natural gas producers, with whom CONSOL competes.

On June 29, 2023, the five largest institutional stockholders, some of which represent index fund investments that match the overall market, were BlackRock (15.6%), hedge fund Greenlight Capital (8.0%), State Street (7.1%), Vanguard (6.8%), and Dimensional Fund Advisors (6.4%).

BlackRock and State Street (but not the other three) are signatories to the Net Zero Asset Managers Initiative a group that, as of June 30, 2023, manages $59 trillion in assets worldwide and which--despite disrupted energy supply from Russia - limits hydrocarbon investment via its commitment to achieve net-zero alignment by 2050 or sooner.

Financial and Stock Highlights

With CONSOL's September 11, 2023, closing stock price of $93.31/share, market capitalization is $3.0 billion.

Given a 52-week price range of $49.35-$94.96/share, the closing price is 98% of the 52-week high.

CONSOL's trailing twelve-month ((TTM)) return on assets and return on equity are exceptional at 21% and 70% , respectively. Trailing twelve months' EPS is high at $21.18 for a current price/earnings ratio of 4.4.

TTM operating cash flow was $781 million and levered free cash flow was $457 million.

As of June 30, 2023, the company had $1.34 billion in liabilities and $2.68 billion in assets for a liability-to-asset ratio of 50%. (link to 10Q)

Of the liabilities, current liabilities are $414 million and long-term debt is $207 million.

The ratio of debt to EBITDA is small at 22%.

Analysts' average estimates of 2023 and 2024 EPS are $21.13 and $16.65, respectively, giving a forward P/E range of 4.4-5.6.

CONSOL Energy pays a significant dividend, $4.40/share, for a dividend yield of 4.7%. The company also has a stock repurchase program underway.

The company's mean analyst rating is 1.75, or between "buy," and "strong buy" from four analysts. One analyst considers the stock significantly undervalued.

Notes on Valuation

The company's book value per share of $40.83 is less than half of its market price which suggests very positive investor sentiment.

With an enterprise value (EV) of $2.9 billion, CONSOL'S EV/EBITDA ratio is 2.5, far less than the preferred maximum of 10 or less and so well into bargain territory.

So overall, CEIX has:

• a market capitalization of $3.0 billion,
• an enterprise value of $2.9 billion,
• a balance sheet asset value of $2.7 billion .

Positive and Negative Risks

Investors should consider their US and global coal demand expectations - as the factor most likely to affect CEIX.

Inflation is high and is expected to stay so. This will affect the company's costs for mining and financing.

Other risks are political and regulatory - particularly with the US federal government, many state governments, environmental regulatory agencies, banks, and investor funds - taking a race-to-zero-hydrocarbons posture. In the face of disrupted Russian gas supplies (and the consequent dire need for energy supplies of all kinds), this may have modulated somewhat, especially in Germany.

And, while China is a big coal consumer, it is also a big coal producer.

Recommendations for CONSOL Energy

With its bargain current and forward price/earnings ratios, investor-friendly stock repurchase program, and 4.7% dividend yield, dividend hunters may want to buy CONSOL Energy and should consider doing so.

While its low debt is attractive, with a 70% stock price run-up since May 2023 alone, investors seeking capital appreciation may want to look for a lower entry point for a stock currently at 98% of its 52-week high. These investors - and I am among them for this stock - may rate CONSOL Energy as a hold.

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