(NYSE: KBR) Short and sweet—opportunities in clean coal
The ‘clean coal’ movement seemed to hold a great deal of promise. It was initially thought to be a way to provide the coal industry with a smooth landing of sorts, amid a broader push in the U.S. to move away from coal toward cleaner alternatives such as natural gas and renewables. Clean coal was hailed by the coal industry, as it represented a method for coal companies to remain economically viable in an era of low natural gas prices, which had greatly incentivized utilities to switch from coal to natural gas as a source of power generation.
In turn, major coal producers invested heavily in clean-coal technologies and plants. Looking back, this was a poor decision. Not only has the clean coal movement failed to stem the massive decline in demand for coal, but coal companies that spent considerable resources in clean coal assets are now forced to sell off those assets for a fraction of their cost, only worsening their financial stresses.
Investors may be able to take advantage of the end of the road for an industry that never really fulfilled on its promise.
Clean Coal Falls Apart
A big indicator that the clean coal movement may be nearing its end is that coal companies that had invested aggressively in clean-coal assets are now selling these assets, for a fraction of the initial cost. For example, Peabody Energy (NYSE: BTU), the largest coal producer in the country, recently sold its stake in a clean-coal facility in Illinois for a massive loss. Peabody has had to sell off considerable assets just to stay afloat, as its fundamentals have deteriorated over the past year. Last quarter alone, Peabody lost $144 million from its continuing operations.
Peabody initially invested $250 million to acquire a 5 percent stake in the Prairie State Energy campus, a massive 1,600 megawatt facility built in 2012. At the time, the project was hailed as a revolutionary breakthrough in clean coal technology. But those days seem like a distant memory. Clean coal facilities like Prairie State saw just as much erosion in underlying demand as traditional coal-fired plants. This has forced Peabody to sell its 5 percent stake for $57 million, which is just 23 percent of its original value.
When the facility was opened, Peabody said it would be a boon for local customers. The rationale was that the clean coal technologies being employed would lower customer bills, as well as provide fewer harmful environmental effects than traditional coal-burning techniques. But none of this has materialized. Instead, local customers have had to pay higher than normal electricity bills, to pay for cost overruns from the project. It highlights the deep trouble facing the clean-coal movement.
A Possible Short Candidate
Investors clearly do not need another reason to stay away from taking long positions in coal stocks. Coal miners are in disastrous financial condition--many coal miners have already filed for bankruptcy protection in the past year, including Walter Energy and Patriot Coal. That being said, a potentially profitable short idea could be KBR (NYSE: KBR), a company that provides engineering and technology services to the basic materials industry. KBR isn’t a coal miner itself, but it does cater a significant amount of its business to the coal industry. This has spared its stock price in relation to coal stocks, but that could change. KBR is the company behind a technology called Transport Integrated Gasification or TRIG, which is used to generate power from lignite coal. Generating power from lignite was a cornerstone of the clean coal movement because generating power from lignite coal supposedly produced fewer harmful emissions than traditional coal burning techniques, at a lower cost as well.
That is why electric utility giant Southern Co. (NYSE: SO) built its massive Kemper plant utilizing this TRIG technology. But the Kemper project has been besieged by start-up delays and significant cost over-runs. The project is expected to come in several billion dollars above initial projections. Add to this the fact that the broader electric utility industry is moving away from coal in general, and KBR could be an attractive short. Near $13 per share, KBR stock has already lost 30 percent of its value just in the past three months, as the grim reality of what is happening in the coal industry starts to spread outside of coal miners, to the company that service the industry.
But further downside potential is definitely possible. KBR stock has not been hit nearly as hard as coal mining stocks. The reason is likely because KBR still gets credit from the investment community for its high-level TRIG technology. Although KBR's technology could be considered superior to what's currently used, even a superior technology can't defend itself against the structural change taking place from coal to natural gas. KBR’s fundamentals reflect this challenge.
KBR’s revenue declined 18 percent in the first nine months of 2015, so another year of losses is a distinct possibility. KBR has experienced a very sudden deterioration in profitability. If the clean coal movement crumbles further, it will continue to pressure KBR’s earnings.
Companies to Watch
Duke Energy (NYSE: DUK): Duke Energy stock could experience significant downside because of significant regulatory risk. Duke has remained steadfast in using coal as a source of power. Two years ago Duke was responsible for one of the worst spills of coal ash, a toxic waste material, in U.S. history. The financial costs of the clean-up could stretch into the billions.
CONSOL Energy (NYSE: CNX): CONSOL has not declared bankruptcy like so many of its peers in the coal industry, but its operations are deteriorating quickly. The company lost $374 million last year, reversing a $163 million profit from 2014. CONSOL stock could be a compelling short opportunity as the company’s losses are not likely to improve this year, due to continued pressure on coal.
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.