The Best Value in Coal Country
By NAUREEN S. MALIK
THE DARK CLOUD hanging over coal miner Massey Energy could be clearing up.
America's fourth-largest coal company has amassed a great deal of bearish sentiment in recent months due to soft coal prices -- mainly for thermal coal used by electric utilities -- and a pair of environmental lawsuits.
At $21.57, the stock is still down 6% year-to-date whereas the Dow Jones U.S. Coal Index is up 25%.
But concerns about Massey's prospects appear overdone and strong demand for metallurgical coal used to make steel could give some pep to the recovering stock. And right now, Massey is the cheapest stock in its industry based on several valuation metrics.
Massey is posting strong results this year as cost cutting boosts margins. While cold winter could ease the pricing pressure due to high inventories at utilities, depressed coal prices are expected to squeeze out competition and give Massey an opportunity to make acquisitions.
Massey's greatest upside, however, is its metallurgical coal, due to strong global demand for steel. Massey is the leading U.S. producer of this coal, generating nearly a third of its revenues from this source.
Massey is no longer trading at a double-digit premium to its peers or to the Standard & Poor's 500 index. Its shares are trading at a 44% discount to its own historical valuation at 14.6 times estimated earnings for the next four quarters.
At value investor Heartland Advisors, portfolio manager Bradford Evans and analyst Jason Schacht calculate that Massey is also trading at an attractive valuation of 5.5-6 times enterprise value-to-2007 estimated earnings before interest, taxes, depreciation and amortization.
They compare that to pricier EV/EBITDA valuations of 13-14 times at Peabody Energy, 12-13 times at Arch Coal, 9-10 times at Consol Energy, 8 times at Alpha Natural Resources.
"The multiples for Massey Energy are very attractive and as value investors that's really what gets us excited about this stock," says Schacht. "If we can find an industry leader trading below market multiples, that's something buy."
Massey shares could gain 35% or double in the next 12 months, he estimates.
Despite weakened coal prices and higher costs to meet regulatory standards, Massey Chief Executive Officer Don Blankenship told Barron's Online that "you will see" double-digit earnings growth at Massey in each of the next several years. He expects to raise production 20%-35% over the next five years as other Central Appalachian miners cut capacity.
Massey is the region's leading coal miner, producing more than 42 million tons of coal a year out of West Virginia, Kentucky and Virginia. It has more than 2 billion in reserves. Thermal, or steam, coal makes up two-thirds of Massey's production, with metallurgical coal making up the rest. Massey exports 8% of its production to Canada and another 15% mainly to markets around the Atlantic.
Robust growth catapulted Massey shares from $5 in late 2003 to more than $55 two years later. It tumbled last year after a mine fire and high labor turnover slashed Massey's 2006 earnings to 31 cents a share, from 83 cents in 2005. Analysts surveyed by Thomson Financial expect Massey to earn $1.53 this year.
About 95% of U.S. coal is used to generate electricity and last year's warm winter has resulted in inventories that are 19% ahead of their five-year average at utilities, says Ann Kohler, managing director of energy at Caris & Co. Demand heightened by the 2005 hurricanes that raised high natural gas prices pushed Central Appalachian thermal to around $65 a ton in early 2006. It recently traded around $45.
At a Glance:
Massey Energy (MEE)
Stock Price: $21.62
52-Wk High: $30.73
52-Wk Low: $16.01
Market Cap: $1.75 billion
Est. 2007 EPS: $1.53
2007 P/E: 14.6x
Est. Long-Term EPS Growth: * 22%
Est. ('07/'06) EPS Growth: 493%
Revenue (trailing 12 months): $2.24 billion
Dividend Yield: 0.7%
Chief Executive Officer: Don L. Blankenship
Headquarters: Richmond, Va.
* Based on analyst estimates looking ahead three to five years.
Sources: Yahoo! Finance, Thomson First Call, Thomson Financial/BaselineBlankenship sees high inventories and low coal prices as a "tremendous opportunity" for growth in the next 12-18 months: these conditions will create opportunities for Massey to acquire distressed miners and reduce labor competition.
Labor turnover has declined to about 13%-15% compared to 30% at the beginning of 2006, says Kohler. This more stable, productive workforce, plus a "modest improvement" on coal pricing should boost Massey's earnings to $1.62 a share in 2008.
Massey's thermal coal production for 2008 and most of 2009 is locked in contracts. Michael Dudas, metals and mining analyst at Bear Stearns, expects these to help Massey "generate good margins" in 2008.
The company has ample cash on balance and additional credit available to fund acquisitions and its share buyback program.
Still, Kohler says, "I like Massey solely due to their metallurgical coal market."
The weak U.S. dollar, high freight costs, tight growth in supplies from Australia due to port congestion, and strong global demand for steel has made "U.S. metallurgical coal very attractive," Kohler says. "This is the first year that they have received inquiries from Asian consumers."
The real overhang on Massey's stock, Heartland portfolio manager Evans says, is the "fear and concern about the potential adverse effects of litigation" for violating the Clean Water Act in a suit by the Environmental protection agency.
Evans denounces the lofty estimates of $2 billion in fines for thousands of alleged violations and says, "I think the market is overreacting."
Massey CEO Blankenship says: "We feel that the government is being unreasonable" and that concerning this lawsuit he is "very comfortable it is immaterial."
Third-party consultants peg Massey's liabilities at $1.5 million to $7 million. Blankenship, whose estimates range from no fines to $1 million, says that Massey could have settled out of court but opted not to in order to set precedence for other cases.
Another lawsuit is trying to rescind permits allowing for mountain-top mining in West Virginia. Blankenship expects the issue to be resolved and says that Massey has the ability to shift to other reserves to shore up production.
Certainly, a further pullback in coal prices, high costs related to regulations and law suits or other economic pressures could derail Massey's growth picture.
However, Bear Stearns analyst Dudas says that so far it looks like that Massey's strong balance sheet, overall consumer demand for metallurgical coal, and the weak dollar offer "some positive catalysts that should help move the stock higher."
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