Tuesday, November 19, 2013

Consol Energy: Carrying Coal into the Future

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Consol Energy: Carrying Coal into the Future

Thomas Scarlett

When you think about cutting-edge energy production, a company that's been involved in coal mining since the Civil War may not be the first one that springs to mind. But Consol Energy Inc. (NYSE: CNX) has been adapting by expanding its operations in natural gas and other sectors, and we think its shares are undervalued.

With more than 9,000 employees, Consol is the leading diversified energy producer in the Appalachian basin. Consol produces both natural gas and high-BTU coal. Together, natural gas and coal fuel two-thirds of the nation's power.

The Pittsburgh-based company has 12 bituminous coal mining complexes in four states and reports proven and probable coal reserves of 4.2 billion tons.  The company's premium Appalachian coal is sold worldwide to electricity generators and steelmakers.

In natural gas, Consol Energy has transformed itself from a pure-play coalbed methane producer to a full-fledged exploration and production company. The company is a leading producer in the Marcellus Shale and is transitioning its active exploration program into development mode in the Utica Shale.  Consol Energy has proved natural gas reserves of 4.0 trillion cubic feet.

Domestic coal producers are facing stiff challenges. Consol is not abandoning that industry entirely, but it is concentrating more on producing coal for export.  The company has longstanding relationships with customers in Europe, Brazil and the Pacific Rim, so it should be able to still derive some profits from its coal business.

The company has entered into an agreement to sell its Consolidation Coal Company (CCC) subsidiary, which contains all five of its longwall coal mines in West Virginia, to Murray Energy Corporation (Murray) for $4.4 billion in value.

"While this transaction furthers Consol's growth strategy," commented J. Brett Harvey, chairman and CEO, "the sale of these five mines - assets that have long contributed to America's economic strength and our company's legacy - was a very difficult decision for our team. The employees at these mines are among the safest and most productive miners anywhere in the world.  In the end, we concluded that the time had come to sell these mature assets to ownership whose strategic direction is more aligned with those mines."

He added: "We're not leaving the mining business; we're growing the energy business. It wasn't easy for us to make the decision to shift our strategy away from those mines to a growth area."

Operational safety is a core value, and Consol Energy boasts a record of almost two times better than the industry average for underground bituminous coal mines.   Consol Energy has total revenues of $5.5 billion, good enough to make the Fortune 500.

Consol reported a net loss for the quarter that ended September 30 of $64 million, or a loss of $0.28 per diluted share, compared to a loss of $11 million, or $0.05 per diluted share from the year-earlier quarter.

The Gas Division showed noticeable expansion as the average sales price was nearly unchanged, while unit costs were lower, mostly due to higher volumes. Overall natural gas production was up 17 percent, aided by the 72 percent  growth in the Marcellus Shale component.

The Gas Division is on track to meet its 2014 production goals. For 2015 and 2016, the company has announced annual production guidance increases of between 25 and 30 percent.

"Consol's Gas Division continues to see the Marcellus Shale become a greater portion of the production mix," Harvey said. "This is important for two main reasons: the first is the lower-cost nature of the Marcellus resulting from drilling efficiencies such as pad drilling, and the second is sales price uplift associated with a higher concentration of liquids. Consol is not only on track to meet its 2014 overall gas production guidance but is also on track to more than double its Marcellus Shale production in 2014, compared to 2013."

In the Coal Division, margins decreased primarily as a result of lower sale prices per ton, reflecting a decrease in the global metallurgical and thermal coal markets. Partially offsetting lower sales prices was approximately a 10 percent improvement in costs per ton.

The company's liquidity remains strong at $2.3 billion, while the company continues to invest in value creating projects. Third quarter capital investments were $438 million, which is flat with the year-earlier quarter.

Cash flow from operations in the quarter was $196 million, as compared to $162 million in the year-earlier quarter.

Rumors continue to circulate that the firm might be acquired or undergo substantial restructuring, possibly involving a spinoff of certain business units. Some have argued that, since the coal assets are mature and primarily produce cash, while the natural gas business is more oriented toward long-term growth, Consol should really be two separate companies.

The company will say only that it is "evaluating our overall corporate structure to consider different alternatives to unlock additional value for our shareholders." Such a transaction could cause the stock to rise sharply.

CEO Brett Harvey spoke in front of a large audience at West Virginia University a few weeks ago.
"The world of energy is rapidly changing," he observed. "Science changes energy, and as energy changes, you have to adapt. It has been said that if you want to understand today, you have to research yesterday."

Natural gas is competing with coal more than ever in American homes. Harvey thinks coal will continue to provide 35 or 45 percent of electricity needs domestically for the next 20 to 30 years.

The stock can be quite volatile. In the last two years, the share price soared as high as 45, fell to below 28, improved to 37, dropped below 30, and is currently trading around 36. Investors who are willing to accept some volatility in exchange for the prospect of strong long-term growth should consider Consol Energy.

Tom Scarlett is an investment analyst at Personal Finance and its parent web site Investing Daily.

Massive Markets & Huge Profits

Japan and China. They're the two largest natural gas importers in the world. And for years every natural gas exporter in the world has been vying for their business. But not any longer. Because Australia is building a floating pipeline to both countries. It's just about finished… and when it is, it will slam the door on other exporters.

I'll reveal the winners of this energy battle here.

Australia's Central Bank Must Go It Alone

Ari Charney

Australia may be on the other side of the globe, but the US Federal Reserve's dithering over monetary policy since early May has had an outsize influence on the country's exchange rate. While US investors enjoyed having their gains in Australian equities enhanced by a relatively strong Australian dollar, now that the resource boom has peaked, it's imperative that the currency weaken in order to boost the competitiveness of the country's exports.

The Aussie had been trading above parity with the US dollar for much of 2011 and 2012, and finally fell below this key threshold in early May, as Federal Reserve Chairman Ben Bernanke indicated that the central bank was thinking seriously about how to curtail its extraordinary stimulus, otherwise known as quantitative easing. As the market prepared for a September taper, which, of course, never came to pass, the Aussie fell as low as USD0.89 in late August.

With just a couple press conferences, Bernanke had inadvertently engineered a decline in the Aussie that the Reserve Bank of Australia (RBA) failed to achieve on its own, despite seven rounds of interest rate cuts. The RBA has since cut rates again, in August, bringing its short-term cash rate to 2.5 percent, an all-time low.

Nevertheless, movement in the Aussie as of late continues to be largely correlated with traders' shifting expectations regarding the Fed's monetary policy (and to a lesser extent the strength of the Chinese economy). President Barack Obama's nomination of Janet Yellen to succeed Bernanke as head of the central bank may have even extended the timetable for when the Fed starts to wind down its $85 billion per month bond-purchasing program.

As Bernanke's key deputy at the Fed, Yellen is known to share his dovish stance toward monetary policy. In appearing before the US Senate's Banking Committee on Thursday, she said there was no set time for a taper, though it obviously can't continue indefinitely. She acknowledged that the market's swift reaction to Bernanke's comments in the late spring had forced the Fed to defer its taper, but also said the Fed shouldn't be a prisoner of the market. If confirmed, Yellen can be expected to mirror Bernanke's approach to policymaking, even if their personal style differs.

That means the Aussie likely has a base of support at current levels, which earlier this month the RBA characterized as "uncomfortably high." The currency recently traded near USD0.937, down about 11.6 percent from its year-to-date high in January, but up 5.3 percent since August. According to a Bloomberg survey of economists, the Aussie is expected to trade at USD0.89 next year, while bottoming around USD0.87 in 2016-17.

The RBA says there's a chance the exchange rate could remain near current levels over the next couple years, though a softening resource sector could lead to declining capital inflows, which would help depreciate the currency. But it notes that the currency is largely beholden to the monetary policies of the central banks of the world's larger economies. That means the RBA will have to continue cutting rates to undermine the currency, since it won't be getting any outside help from its central bank peers.

Though our gains are no longer being enhanced by the currency effect, a weakening Aussie should help our companies compete in the global markets. And we expect that performance to ultimately flow through to higher share prices for our recommendations, which should more than offset the modest decline in the currency.

This article originally appeared in the Down Under Digest column. Never miss an issue. Sign up to receive Down Under Digest by email.

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A Drug Company Addicted to Growth

Benjamin Shepherd As America's baby boomers grow older, complaints of chronic pain are on the rise.

A report released last year by the Institute of Medicine, one of the United States National Academies, found that about 100 million Americans reported suffering from some form of chronic pain in the past year at a total societal cost of nearly $635 billion. More people suffer from chronic pain in any given year than those who suffer from diabetes, coronary heart disease and cancer combined.

As chronic pain has become more prevalent in America, so have the opioid pain relievers most commonly used to treat it. Between 1999 and 2008, the sale of such drugs increased by 300 percent while the number of prescriptions written for them shot up from about 75.5 million to 209.5 million.

Unfortunately, opioid pain relievers act on the same neurological pathways as heroin, making them highly addictive and increasing the potential for abuse. It's estimated that in 2011, nearly 2 million people in the US alone meet the generally accepted criteria for opioid abuse or dependence.

Amid the growing use and misuse of opioid pain relievers, the race is on to create effective, opioid-like pain relievers with lower potential for abuse.

Mallinckrodt PLC
(NYSE: MNK), which resulted from Covidien's (NYSE:COV) pharmaceutical business spinoff this past June, is leading the charge in that arena.

Mallinckrodt operates in several channels: it manufacturers active pharmaceutical ingredients (API), which it markets to other pharmaceutical companies; uses its APIs to develop and manufacture its own branded and generic drugs; and has a global medical imaging businesses that develops, manufactures and sells contrast media and delivery systems, including nuclear imaging agents.

Since the company's spinout, it has made a modest gain of just 5.7 percent, largely thanks to the fact that the company's 180-day exclusivity period on generic Concerta has expired and will lose its protections next year. Because of that looming expiration, management has issued earnings per share guidance significantly below this year's earnings.

The earnings downgrade has created an attractive entry point for investors to take advantage of four new drugs that the company will introduce to the market over the next 18 months or so.

Two new branded products, Xartemix XR and Pennsaid, have been submitted to the FDA for approval and are designed to treat acute and moderate-to-severe pain with abuse-deterrent characteristics that make them excellent alternatives to currently used opioids with high abuse potential. The company's new formulation of its Concerta pain medication is also currently under review by the FDA and all three drugs are scheduled for launch by the end of next year.

According to data from Mallinckrodt, the acute pain market is valued at nearly $3 billion, with $1.2 billion worth of prescriptions written annually in the company's target market. If it offers attractive alternatives to opioids, it can snag a large share of that spending for itself in fairly short order, particularly by targeting the specialized pain treatment practices that have sprung up around the country. Specializing in treating patients with chronic pain, those practices will be eager for less additive alternative pain treatments, which will ultimately reduce their potential legal liability.

Thanks to aggressive patenting strategies, Mallinckrodt will enjoy patent protections on its new products through 2032. Although they won't render the company's products bulletproof, those protections will at least reduce the potential for new competition to enter the market.

One of the company's key growth strategies will be to heavily invest in research and development to exploit its patent portfolio in less addictive pain medications.

In addition to those new drugs, Mallinckrodt also has a few other competitive advantages that make it attractive. Through its generics and API businesses, the company currently holds a 40 percent share in controlled substances as defined by the Drug Enforcement Administration (DEA), through licenses it holds to manufacture those drugs. In particular, it holds a 32 percent market share of DEA schedule II and III opiate compounds.

Mallinckrodt is also the only non-Asian based manufacturer of acetaminophen, the active ingredient in over-the-counter pain relievers such as Tylenol.

Most significantly, about a quarter of the company's revenues are generated by its nuclear imaging segment. This segment is one of only two manufacturers of generators that convert molybdenum-99 into technetium-99 in the US and one of only three in Europe. Given the extremely sensitive nature of that technology, the emergence of any new competitors in that field is extremely unlikely, especially in light of heavy regulatory controls in place.

Because of these existing advantages, Mallinckrodt should be able to hold its own in terms of earnings over the next year. At the same time, it will draw growing amounts of investor attention as its new products enjoy likely FDA approval.

Although its shares will likely remain volatile over the next few months, Mallinckrodt's solid long-term prospects rate it a buy up to 56.

The World Just Shifted

An unexpected Obama policy reversal changes the global energy map, leaving Russia's Vladimir Putin furious. Environmental groups see red. But investors see green.

The global ramifications are enormous. Two companies are poised to profit first. Want to know who they are?

Go straight here.

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