Tuesday, January 19, 2010

U.S. Coal Earnings Playbook [ubs research]

Taking a Closer Look at 4Q

4Q data points to continued declines in production and rail car loadings Operating conditions for US coal producers have remained challenged in 4Q09 as production cuts and delivery deferments have continued to temper revenues and pressure unit costs. Coal stockpiles at electric utilities built to record levels as cool summer weather and inexpensive natgas curbed coal-fired generation; however, 4Q production and rail car data indicate a concerted supply response (down 10.7% and 14.6% y/y, respectively). While the cuts crimp near-term margins, they help rebalance the market and set the stage for a pricing recovery.

Investors may look past actual 4Q results and focus on macro commentary

Given the group’s strong rally and investors’ continued focus on macro data, we expect many to look past the actual earnings results (absent a company-specific material change) and focus on top-down commentary. We look for greater clarity with respect to met coal contract negotiations, management’s outlook for Chinese demand, levels of thermal inventories, and expectations for high-vol recovery.

Our Thoughts: Thermal coal is heating up

Given our view for inventory cleansing in 2010, we prefer eastern producers with thermal leverage to international markets such as CNX and JRCC (our preferred met name is MEE). Supporting this view, data indicates that production curtailments continued through the end of 2009 in response to reduced generation and bloated utility inventories. With signs of economic recovery, our attention is on an eventual recovery in coal-fired generation, which will be heavily dependent on natural gas strip, which has been trading around $6MMBtu on the NYMEX. We
believe this will lead to a reversal of 38mm tons of fuel switching throughout 2010.


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