2023-10-19 03:44:22 ET
Summary
- Global energy markets are experiencing bullish pressures as the international trade of crude oil and natural gas falls into jeopardy again.
- CONSOL Energy has seen a significant rise in its stock price in recent years as coal returns to compensate for lost natural gas flows.
- Fundamentally, coal is a geopolitical hedge because it replaces natural gas, which is increasingly targeted in geopolitical conflicts.
- Based on CONSOL's expected 2024 contract prices, I believe its EPS will likely be around $10.6, probably making it a bit overvalued today.
- Should coal prices rise due to LNG and natural trade issues, then CEIX could be worth much more due to its coal price sensitivity.
Global energy markets are the most sensitive to changes in the geopolitical environment. In light of the renewed Middle Eastern crises, we're seeing bullish strains on oil and a more significant rebound in Eurasian natural gas and US LNG . As natural gas prices increase due to potential shortages, thermal coal often rises because it is the primary alternative commodity, particularly in Asia. For the most part, coal prices remain near 2023 lows today but are resting well above levels seen over the decade before 2021.
After years of poor performance, investors have also become very attracted to coal mining stocks. One notable example is CONSOL Energy ( CEIX ), historically a leading producer of US thermal coal. CEIX has risen by around 91% this year and is stupendously ~30 times higher than it was in its 2020 lows. CONSOL is among the few stocks that came "back from the grave," going from a likely bankrupt old mining company to a high-flying energy stock in three years. For the most part, its EPS has followed its price path, with the stock still trading at a relatively low forward "P/E" ratio of ~5.2X. Of course, due to its stellar performance this year, many detractors have bet against the stock, giving it a higher short interest level of ~7.9%.
The stock's performance has defied the general trend in coal prices. As seen in the coal mining producer price index, coal miner profit margins have likely declined in 2023. CONSOL's EPS has remained high, probably due to price contracts. However, its stock price has risen dramatically in recent months despite stagnation in its EPS trend. See below:
Given the situation, I believe it is an excellent time to take a closer look at CONSOL and the US thermal coal market to determine whether or not CEIX is in a price bubble or is simply rising toward its fair value after being undervalued for too long.
The Future and Present of Thermal Coal
For the past two decades, thermal coal has been the "ugly duckling," a much disliked energy-producing commodity due to its less clean nature. Most Western countries have aggressively shifted toward natural gas, which produces less CO2 and other byproducts than coal. In 2020, it was generally viewed that Asian countries would quickly follow suit, causing thermal coal to become a relic of the past. However, as global instability rose with the lockdowns and subsequent geopolitical conflicts, coal has returned as a more viable commodity. Compared to natural gas, coal is far more abundant, cheaper per MMBTU , and, most importantly, is not exposed to the immense conflict risks of natural gas, as gas pipelines become a primary geopolitical target ( 1 , 2 ).
As Europe has lowered its Russian gas imports, it has dramatically increased US LNG imports, causing far less US LNG to flow toward Asia. As such, Asian countries have significantly increased coal imports to offset lost LNG, causing 2022-2023 to be record years for global coal consumption. Unsurprisingly, CEIX has risen in response to the Israel-Hamas war, up around 9% since October 6th. Fundamentally, any threats to the European-Middle East natural gas trade will create upward pressure on Asian coal demand as more US LNG flows toward Europe (instead of Asia).
Of course, with CEIX being so expensive today compared to its 5-year range, we must consider whether or not it is reasonably priced to that response. For one, coal prices are still far below 2022 levels. The company is producing around the Appalachia-Illinois area, which has seen coal prices drop by over 70% since the 2022 peak. See below:
Coal Price US Market (Energy Information Administration)
There is a vast difference between CONSOL's EPS and the coal miner PPI and spot coal prices because most coal miners use fixed-price contracts and derivatives to minimize income volatility. CONSOL also directly exports around two-thirds of its production abroad, so its sales are often at European and Asian prices, are around $70/ton higher, typically holding the same pattern as US spot prices. Since it owns a central marine terminal, it also earns around ~$100M in quarterly sales (~1/6th of the total) from fees from other coal miners using its infrastructure. Thus, while the general trend in coal spot prices is essential, CONSOL is diversified and has a significant edge against most US competitors.
2024 Income Projection
As the last investor call mentioned, all of its 2023 production was contracted, while 17.6M of its 2024 production (or ~65-75% of the total) was contracted. For the most part, we can expect that CONSOL will earn income in any given quarter based roughly on prices one year prior. During Q2 , the company realized an average price of $81.27/ton at a cash cost of $36.33 per ton, both in line with guidance figures. The company also mentioned that its 2024 pricing was in the mid-60s but has not given specific price points since it was still making contracts. Its contracts will likely be around that level since coal prices have not changed dramatically in recent months.
Assuming cash costs rise by $1.5/ton, as they had from 2022 to 2023, to ~$37.8 (due to inflation), I expect its cash margins per ton will be around $27/ton based on a $65/ton expected realized price. An expected 25M annual production for 2024 should result in about $690M in total mining EBITDA. On top of that, I will project its marine terminal EBITDA at $96M, based on its Q2 performance. Together, that gives us a 2024 EBITDA projection of $786M.
Against that, I will project its depreciation & amortization at $248M (twice its Q1 + Q2 2023 level) and its interest expense at $28M (four times its Q2 level due to recent debt reductions). That gives us a pre-tax income estimate of $414M, or ~$331M, given its typical 20% effective tax rate. That translates to an EPS of ~$10.35. The current 2024 EPS projection by the analyst consensus is a bit higher at $16.65 , but only two analysts are making such a projection, and those figures likely do not account for the more recent coal price changes.
The Bottom Line
Based on my assumptions, I believe CONSOL's 2024 forward "P/E" is around 10.6X but potentially as low as 6.6X based on other analyst projections. Over the past five years , CEIX has traded at an average "P/E" ratio of 4.3X and an average "EV/EBITDA" of 4.85X. In my view, these lower valuation metrics are very reasonable because CONSOL's EPS is extremely sensitive to changes in commodity prices. If coal eventually returned to pre-2021 levels, the company's income would likely become chronically negative again. Of course, should geopolitical turmoil continue to mount, then there is some reason to believe coal could rise much higher by 2024.
Overall, my view regarding CEIX is similar to my outlook for Cheniere ( LNG ). On an immediate basis, projecting current prices into the future, CEIX is likely overvalued by around 30% to 110%, meaning it could fall by 25% to ~54% for its price to fall to a 5X "P/E" based on 2024 EPS projections. The price of coal and global volumes have been relatively stable during the past two quarters, so it is not unreasonable to assume coal could remain in this range in the long run, likely making CEIX overvalued today. CEIX has risen quickly this year despite negative action in coal spot prices, indicating that it is increasing due to retail investor speculation and not improving fundamentals.
Still, I am not bearish on CEIX and am neutral because there is considerable potential that we see coal prices return to 2022 peak levels. CEIX never fully benefited from the price spike last year because it had lower-level price contracts. Thus, should coal rise again as last year, we could easily see CONSOL's EPS rise into the $20-$40+ range. Such an action would require geopolitical pressures on the global natural gas market, as the Russia-Europe natural gas crisis fundamentally triggered last year's coal rally. I obviously do not know if that could occur again, but considering most stocks will lose in this scenario, CEIX may be an excellent hedge to own, being among the few that would benefit.
For further details see:
Consol Energy: Coal Rebounds As A Hedge Against Geopolitical Strife