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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Morgan Stanley And General Electric: There Is Hope For Coal

Events have been so bad in coal for so long that it is easy to lose hope on the sector. Most of the publicly traded coal companies have lost 95 percent of their market value. Events are so negative that the dominant mining equipment maker in the sector, Joy Global, has agreed to sell itself to Japanese construction equipment firm Komatsu at a price that is a fraction of what Joy’s stock fetched a few years ago.

Against this backdrop, it is little wonder that investors are bearish on the industry. Yet in the last week there have been two separate events that suggest there may still be hope for the coal sector – but with a catch. Coal looks like it may have a future primarily outside of the U.S.

First, there are signs of coal shipments among the railroads. Following meetings with Union Pacific management, Morgan Stanley announced last week that coal and agricultural shipments appear headed for a stronger outlook. The upturn in those areas would benefit UNP and its peers with sector exposure. Railroads have been in doldrums for almost as long as coal has been. If coal volumes improve, that will boost profitability across the sector as cargo-volume growth would be immediately profitable due to current excess capacity.

Morgan Stanley noted in their analysis last week that while "visibility remains low, management expressed confidence that any volume rebound in 2017 would likely come with strong incremental margins and minimal service disruption". To be clear, Morgan Stanley is not looking for an immediate improvement. The sector may have bottomed, but recovery will still take time. The bank says that utility coal stockpiles remain large, but they are improving and that growth in coal shipments could arrive by 1H2017. Related: Goldman: The Rally Will Stall Regardless Of OPEC Freeze

The second positive event in the sector comes from industrial giant General Electric. GE is reportedly bullish on coal again the WSJ reports. GE sees opportunities in the space with executives citing opportunities to build long-term revenues through sales of equipment and services to existing coal plants. GE sees the chance to lock in decades of low-risk profits from current coal power plants. Those current plants are increasingly going to face a set of tightening emissions rules that require new pollution control equipment and installation. The regulatory environment shows no signs of changing, so that demand should increase consistently for the foreseeable future. Just as importantly, GE also sees potential from coal facilities construction in developing economies.

With demand for power rising in India and Southeast Asia, coal plant construction is booming. India in particular has a notoriously poor electrical grid that requires extensive upgrades. Southeast Asian economies have less of an infrastructure, but is growing quickly and looking to emulate the success of South Korea, Japan, and even China in developing. General Electric believes it can play a role in aiding those regions through coal power generation equipment.

None of this changes the outlook for coal overnight, nor does it mean that coal is likely to regain its former glory. But coal’s future may not be as bleak as many have assumed. Coal mining even within the U.S. is likely to continue under restructured and downsized coal miners. GE, Joy Global, and investors with the stomach for a stable but not growing industry can benefit from that trend.

By Michael McDonald of Oilprice.com

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