By Aaron Levitt

 

It's been a rough few months for companies and investors in the coal sector.

 

First, advances in hydraulic fracturing and horizontal drilling have unearthed a virtual ocean of natural gas and have dropped prices to decade lows. Those low prices have scads of utilities preferring it over coal. Already, more than 112 older coal-fired power plants are scheduled to retire across the country, as electricity producers switch to cheaper and greener gas. Then came the Obama administration and the EPA's sweeping rules designed to limit carbon-dioxide emissions from new power plants. These rules effectively block the construction of new coal-burning plants and make natural gas even more attractive.

 

Add these two points to slowing global growth, and it's no wonder the coal industry continues to be hit hard.

 

All of these pressures finally have claimed their first victim. Appalachian miner Patriot Coal (PCXCQ) has filed for bankruptcy protection in an effort to improve the company's long-term prospects.

 

For investors, Patriot's filing could be an ominous sign for the rest of the industry. While some bargains are beginning to emerge among coal stocks, caution could be the best medicine.

Widespread ripples

Patriot, which listed $3.6 billion in assets and $3.1 billion in debts, blamed the continuing terrible operating environment for its downfall. The miner has lost money every year since 2010 and recently reported a $198.5 million loss for the year ending March 31.

 

In May, Patriot hired a law firm as well as private equity group Blackstone (BX) to provide options on refinancing its debts and to explore other "strategic initiatives." Given the company's continued losses and burgeoning debts, the bankruptcy filing isn't so shocking. What could be, though, is the ripple effect throughout the entire sector.

 

Patriot Chairman and Chief Executive Irl F. Engelhardt summed it up perfectly in a statement regarding the company's filing that the "The coal industry is undergoing a major transformation." That transformation is turning into a painful metamorphosis for investors.

 

At the same time falling demand has chopped coal prices, industry costs are rising as Massey Energy's 2010 mine explosion has caused stricter workplace rules for miners. Together with EPA rules banning mountaintop strip mining and carbon emissions, you have a recipe for one of the worst operating environments for the coal industry in decades. Many miners have been able to survive only via capacity cuts and mine closures. These factors have promoted a variety of analysts and investors to predict that more companys within the sector will follow Patriot's example and take the bankruptcy plunge.

 

Cash-flow-negative small miner James River Coal (JRCC) fell nearly 24% on Patriot's news as analysts predict the company will surely file a similar bankruptcy plan. Likewise, industry stalwarts Alpha Natural Resources (ANR) and Arch Coal (ACI) fell 7.22% and 8.6%, respectively, as both companies' high debt burdens could be an issue going forward.

No time for bargain-hunting

With broad sector measures like the Market Vectors Coal ETF (KOL) down nearly 24% this year as natural gas continues to eat coal's lunch, the temptation is to look for bargains among the rubble. There certainly are some. Powder River Basin leaders and strong producers Peabody Energy (BTU) and Cloud Peak Energy (CLD) can now be had for a fraction of their 52-week highs.

 

However, I'm not sure I would want to nimble quite yet. Patriot's bankruptcy certainly puts another cloud over the already sticky coal environment -- one that isn't getting any better, at least in the near term. However, should more coal miners embrace Chapter 11, that sort of industrywide shakeup often leads to consolidation as the stronger players feast on weak.

 

The sector will most likely see a few more big dips as the shakeout continues. That will leave plenty of other opportunities to pick up shares of the surviving and better-capitalized miners for cheap. Until then, I'd focus my efforts elsewhere and keep some powder dry for a later buying opportunity.

 

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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