Coal investors finally heaved a sigh of relief following an improved outlook by Moody's for the sector. This comes as the space has been grappling with stringent environmental legislation aiming to lower carbon pollution in America, increased competition from alternative energy sources, sluggish demand from key markets, and a strong dollar.
Moody’s Upgraded Coal Industry Outlook to Stable
Amid such a situation, Moody’s comment that it “does not expect industry fundamentals to deteriorate further over the next 12 to 18 months, though business conditions remain very weak” sent coal stocks rallying. Moody’s also raised its coal industry outlook to stable from negative, helping some to feel a little less bearish on the space (see Are Coal ETFs Back on Track?).
The reason for this upgrade can be traced back to a host of positive developments. These is a continued rise in natural gas prices which should trigger demand for the thermal coal segment through mid-2014 to early 2015 and supply rationalization in metallurgical coal which is used for steelmaking.
Moody’s now expects coal’s share in electricity generation in 2013 to reach 40%, up from 37% in 2012. Further, a substantial fall in coal inventories should translate into higher thermal coal production and a consequent improvement in pricing by next year.
How to Play
There is only one ETF, namely Market Vectors Coal ETF (KOL), which offers a pure play on the US coal industry. The ETF was down about 25.5% on a year-to-date basis but Moody’s upgraded coal outlook put this fund in focus. In the last five-days ended August 12, the fund gained 7.4%, while it is up 5.6% in the last month ending August 16th.
KOL in Detail
Launched in January 2008, KOL tracks the Stowe Coal Index, providing exposure to the companies related to the coal industry. Even though this index has a global focus, nearly 57% of its investments are directed towards U.S. companies, followed by China with a 13% share.
The Coal Index comprises companies that generate at least 50% of their total revenue from any form of coal-related activities. The activities range from production and mining, coal transportation, production of coal mining equipment as well as coal storage.
KOL amassed an asset base of $159.4 million and charges 59 basis points in fees annually. This fund holds 33 stocks and the top 10 companies hold a 56.7% share of total net assets. The average daily volume is about 135,000 shares and the fund has a dividend yield of 2.30% (as of August 2013).
Among individual holdings, top stocks in the ETF include CONSOL Energy Inc, China Shenhua Energy Company Limited, Joy Global Inc. and Peabody Energy Corp comprising a respective 8.44%, 7.93%, 7.18% and 7.15% of the fund (Read: Coal ETF Surges on Peabody (BTU) Earnings Beat).
While KOL currently holds a Zacks ETF Rank #4 (Sell), the valuation of coal stocks has perhaps bottomed out and can call for a trend reversal. Further, some good corporate earnings reports from coal companies as well as increased electricity and steel demand in the U.S. are also suggesting that the worst might be over for the space (also read 3 ETFs for a Nuclear Power Renaissance).
However, the risk quotient of the fund is high given more than 50% exposure to mid-cap and about 23% to small-cap stocks, which makes the fund volatile. Further, KOL will be highly vulnerable to currency-translation risk as about 50% of its assets are exposed to foreign currencies. In addition, the overall sluggish commodity market adds to the risk profile, suggesting that extreme caution still needs to be taken in this uncertain market segment.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>