Goldman Weighs In On Coal Sector; Chooses SunCoke And Consol Energy As Frontrunners; Recommends Arch Coal At Sell

Goldman Sachs once again made waves Friday morning after it transferred coverage of coal stocks from Brian Singer to Neil Mehta, initiating the sector with a Neutral rating.

While Mehta noted that the sector still faces major challenges ranging from coal plant retirements, to low met/thermal prices relative to historical averages, and high net debt, he still believes there are some plays to be made in the sector.

The primary thesis of his report was that the coal sector has underperformed the S&P 500 by 44 percent this year, while spot met prices have likely hit a bottom.

Mehta's report laid out three primary ideas:

• 1. Own “sum of the parts” stories such as Consol Energy CNX and SunCoke Energy SXC
• 2. Avoid pure play coal stocks such as Arch Coal ACI given long-term declines in thermal volumes
• 3. Favor names with strong balance sheets such as Consol Energy and Suncoke over names like Arch Coal

Individually in the report, Mehta bumped up Consol Energy to a Buy rating, while raising its price target from $35 to $43. The thesis on Consol centered around strong production growth in its E&P segment, which would serve to improve the company’s cash flow from its coal business. Mehta believes this increased cash flow could serve to improve the chance of an asset sale, or at least restructuring, while also supporting a strong sum of the parts valuation.

Other upgrades included Alpha Natural Resources ANR and Walter Energy WLT, both from Sell to Neutral, with a bump from a $4 to a $6 price target, and an increase from a $10 to a $15 price target, respectively. The thesis here being simple: Mehta believes that met coal prices have bottomed, or at least come close, and that Arch Coal has a much greater downside.

On the bearish side, Arch Coal was downgraded to a Sell rating from Neutral, while dropping its price target from $4 to $3. Arch Coal was highlighted as a Sell with a simple thesis: its over leveraged, its probably reached its peak valuation, and it has a low level of free cash flow.

The other downgrade in the report was on Cloud Peak Energy CLD, which was lowered from a Buy to a Neutral, while dropping the price target from $19 to $15. Again a simple thesis on this one: Mehta lowered his production outlook on the company, while dropping its PRB price forecast, both contributing to a more bearish outlook.

Following the report, Consol Energy gained 0.56 percent to $33.96, SunCoke Energy fell 0.15 percent to $16.75, Alpha Natural Resources rose 0.32 percent to $6.29, Walter Energy traded flat, Arch Coal dropped 3.97 percent to $4.35, and Cloud Peak dropped 2.3 percent to $14.85.