Wednesday, September 23, 2009

U.S. Coal Sector Downgraded to Neutral from Overweight at Macquarie

Macquarie Group might not be very well known in the U.S., but they are making a big call on the U.S. coal sector, downgrading their sector weighting to Neutral from Overweight:

We are downgrading our ratings on the U.S. coal sector to Neutral from Overweight as we believe demand for seaborne metallurgical coal in China is slowing following discussions with Macquarie’s network of global physical coal traders and our commodity team. We have heard from Canadian producers that the Chinese have pushed back on deliveries and there appears to be an absence of new demand in Australia, suggesting that coking coal imports for September and October could fall sharply. The main export markets for U.S. coking coal of Europe and Brazil remain very weak and prices for spot met coal in the Atlantic Basin remain well below the Pacific Basin, limiting upside for U.S. companies.

If China really slows down, high-beta US coal stocks at risk. We have been very bullish on the US coal sector since June when global met coal and Chinese steel fundamentals were starting inflect to the upside and sentiment on the met coal market was generally bearish. The U.S. coal sector is up ~100% in the past two quarters and we see risk in the short run. We forecast Chinese imports to slow in 4Q owing to lower steel production and rising local mine supply which would be a negative catalyst for U.S. coal equities in our view. Also, thermal fundamentals continue to worsen and we expect producers to lower 2010 volume expectations this quarter offsetting much of the benefits of better coking coal fundamentals.

Increased Pacific met demand does not benefit US producers that much. US met coal producers ship very little met coal into Asian markets as the majority of tons are sold to US and Canadian customers. Brazil, and Europe account for 75% of U.S. met export volume and these markets remain extremely weak with excess inventory of coke and depressed steel mill operating rates. U.S. coal producers have not seen any major pick up in orders from Europe yet.

Met prices are soft in the US and Europe; thermal market remains very weak. The strength in met prices in the Pacific has not translated into higher European or US met prices. We believe prices for high-quality met are not higher than US$100/ton into Europe right now and are around US$95/ton in the US. The high-vol market remains oversupplied with weak prices near US$85/ton. US thermal prices continue to weaken and we expect rising inventories in the fall should drive new production cuts and reduced volume / price expectations for 2010.

Macquarie is lowering ratings on individual coal stocks as following:
Alpha Natural (NYSE:ANR) to Neutral from Outperform
CONSOL Energy (NYSE:CNX) to Neutral from Outperform
Massey Energy (NYSE:MEE) to Neutral from Outperform
Patriot Coal (NYSE:PCX) to Underperform from Outperform
Peabody Energy (NYSE:BTU) to Underperform from Outperform

Action: This is a call everyone invested in coal stocks should pay attention to. There hasn't been anything negative said on the sector recently, maybe only that valuations are getting a bit expensive. And now Macquarie is saying Chinese are pushing back deliveries & no new demand from Australia.. Wow. That doesn't sound too good, does it?

The only problem I have with this call is (potentially unfounded) relative lack of recognition of Macquarie among U.S. investors & traders. If this call was coming from a Tier-1, it would make headlines all over the media.. now it might go under the radar. Well, at least until some better known house comes out saying the same thing and everybody finds out that hey, there was somebody saying it before.

It also makes it difficult to make a call on the stocks. I would really like to go short in all the stocks mentioned, but it might take a bit too long until the word spreads. Maybe the best idea would be start with like 1/2 of position early on to be involved and add the rest after seeing this call making any headlines.

Update: Note that ANR & BTU were upgraded to Buy at Citigroup yesterday, getting only somewhat muted reaction in stock prices.

Update 2: FBR is downgrading WLT on valuation.

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