NC - NACCO Industries: Coal Outlook Is Bleak As Green Energy Ramps Up

2023-11-10 23:37:03 ET

Summary

• Coal industry outlook is challenging with increasing investments in renewables.
• NACCO Industries Inc. offers little value for investors and is not recommended for long-term investment.
• NC's operations are diversified across coal mining, North American mining, and minerals management, but face declining demand and poor financial performance.

Investment Rundown

The outlook for coal seems very challenging as more and more investments are pouring into renewables. The valuation right now for NACCO Industries Inc ( NC ) has largely stayed the same for the last 9 months or so. I think it has been a rather development as the company doesn't offer any significant value for investors here. The last quarterly report posted by NC displayed little excitement I think as the company experienced a significant decline in the operating results following decreases across the segments.

Coal is facing a lot of challenges and it's not an industry I would want to be invested in right now. The risks are amounting and NC will most likely yield a poor return over the long term. In a lot of cases, companies like NC aim to provide a strong dividend yield to make up for this, but it right now is at just 2.5%, and seeing the 5-year return being a negative 5% for the share price I would run for the hills here. If it's not obvious yet I am not very bullish on NC and will be rating it a sell now.

Company Segments

NC is involved in the natural resources sector. The company's operations are organized into three distinct segments: Coal Mining, North American Mining, and Minerals Management. The Coal Mining segment is responsible for the operation of surface coal mines under long-term contracts, serving power generation companies and an activated carbon producer. These mining activities are conducted across several locations in the United States, including North Dakota, Texas, Mississippi, and Louisiana, as well as on Navajo Nation lands in New Mexico. The diversified nature of NC operations across these segments positions it as a significant player in the natural resources industry, and its performance is closely tied to developments in these sectors.

In its recent report , NC offered insights into the outlook for the coal industry. The company anticipates a gradual decline in coal deliveries, projecting a modest decrease compared to 2022 levels. This outlook is influenced by several factors, with the cessation of deliveries from the Sabine mine being a notable contributor to this less favorable perspective. The changing landscape of the coal market poses challenges and opportunities for NC as it navigates evolving dynamics in the industry. Some of these opportunities are that markets like India and China still remain very open to coal as an energy source. This could lead to continued capabilities of NC paying out its dividend to shareholders and bring some value.

The company has coal mines across the US but when we look at the total asset growth in the last decade it has depreciated by 2.88% yearly. This to me indicates that NC is not in a market environment where it makes sense to invest in more mining infrastructure and equipment. The returns simply don't seem to be there right now, and unlikely will be either. The coal industry is faced with a lot of challenges as demand falters. Demand may be strong in Asia as it's still a cheap source of energy, but it will be phased out in favor of green energy in due time. The reason for the record-setting usages is the lower prices which for economies like China and India is favorable and leads to the uptick in coal deliveries globally. One of the key things the report notes though is that global growth in electricity demand and growth in green energy investments are narrowing which suggests that coal will soon begin a terminal decline in the coming decades. With yearly record levels of how much energy is coming from wind or solar, it's clear where the investments are going and how little are left for emission-producing sources like coal. The one market where coal is expected to grow is India. However, this market is right now in the midst of a boom, and getting a hold of cheaper energy options is a key reason for the increase. I do expect that in time India will also see a decline in demand for coal as they aim to switch to more renewable energy options further hurting global demand for coal.

Looking at the US though where NC is operating we can see a pretty clear decrease across the markets. Since 2010 the demand for coal and the output has severely declined, almost 2% annually with some spikes upwards here and there. I don't think there will be anything fundamentally that will shift this current trend and that means NC has a honestly pretty dismal market outlook right now.

Earnings Highlights

I have mentioned already that NC saw a pretty bad YoY development on the balance sheet as the net income became negative for the quarter, a 136% decrease from last year's results. Net income was negative $3.8 million. The results were largely due to lower customer demand across the Coal Mining and Minerals Management segments for the business.

The number of shipments and deliveries was also down significantly YoY, roughly 38% to be exact. The outlook that the management provided for the coming Q4 report is that it will display substantial improvements compared to these Q3 results, but still show significant decreases YoY as the price of coal has collapsed. I think that we are at a point where if NC puts up bad numbers next quarter the share price will plummet hard. The company has a TTM p/e of 14 and I don't think one higher than 6 - 7 is justified if the company can't maintain margins or see bottom-line growth. The broader sector is trading under 10, and given the clear challenges that face NC in the coming years like heavy investments into clean energy reducing the usage of coal, it's reasonable to justify a lower valuation here to adequately account for the risks. At that point, it's better off staying away and selling any stake in the business. We have discussed the long-term headwinds that coal is facing and that I think will weigh on the coal price development as a result, meaning it won't appreciate as much as investors may hope.

I won't be more optimistic about NC until they see a reversal in customer activity but I heavily doubt that will happen to a significant level given the headwinds already mentioned. Selling is reasonable here as the risks are increasing each day it feels like.

Risks And Risks To Thesis

Looking at the risks for NC one of the most salient factors is the pronounced volatility in both commodity prices and the cost of sales. Fluctuations in commodity prices are a common occurrence and are generally factored into investor expectations. However, when these price shifts coincide with an upsurge in the cost of sales for a mining company, it can lead to challenging quarters and diminished returns. The impact of lower coal prices has been visible on the earnings reports in a negative manner along with lower customer activity too.

Unfortunately, shareholders of NC have experienced not only this price-cost dynamic but also the repercussions of share dilution in recent years, which has further tempered the potential for significant appreciation in their positions. I think that seeing clear fluctuations between the quarterly results is to be expected and right now the coal prices seem to be trending down too, further pressuring the earnings of NC.

Where NC has been further hurting shareholders is through the steady practices of share dilution it has had over the past years. Since 2019 the share count has climbed by 1.7% annually. This seems to be caused by stock-based compensation which in the last 12 months amounted to $7.5 million in total. What baffles me is that NC is also spending earnings on buying back shares at the same time. In the last 12 months, it was almost $1 million in total. This sort of backward and counterproductive move is what is moving me away from investing in the company and supports a sell case here. As stated in the last report these buybacks were in the last quarter alone.

One of the risks that my thesis does face is that investments into clean energy start to slow down and this will inevitably lead to a prolonged demand for coal and other unclean energy sources. I do think a cause could be that capital is not as easily accessible anymore, caused by higher interest rates for a longer time. This may prove to be short-term headwinds rather than something that actually determines the long-term outlook and results. I still believe very much that coal, oil, and gas will eventually be phased out completely when that might be a different question, but I am not willing to bet on the opposite happening.

Final Words

Coal is not an area I want to be invested in right now. It doesn't matter that NC has a dividend yield of 2.5%, the fact of the matter is that NC is facing significant long-term headwinds involving lower and lower demand each year for coal. If the company can't transform itself into something else that can ride on the green energy wave we are unlikely to see the share price at a higher level than today. The price will likely plummet should there not be a good enough recovery in the Q4 report and this all concludes me rating NC a sell right now.

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