If the financial apocalypse arrives anytime soon, I don’t have a gun in the house…but I might have some tomatoes. I got some plants in the garden over the weekend.
How nice to see those green shoots in the ground.
There are certainly plenty of grim headlines out there in the world right now.
But here’s something positive…
Australia’s trade surplus is getting along just fine. The June quarter of this year saw the largest on record.
I couldn’t help but wonder however, whilst hammering stakes into the dirt, how long that can last considering the long term trends in the coal industry.
The Outlook for Coal Stocks
This is no small thing. Coal accounted for 3.5% of our GDP in 2018.
Here’s why I bring it up.
Reuters reported1 on a study that concludes that $71 billion in Japanese coal assets could soon be at risk from cheaper renewable technology for power generation.
That would be a major problem for Australian exports if so…
The Reserve Bank of Australia says Japan accounted for 40% of our thermal coal last year. This is used for power generation.
That’s a big chunk of market share in anyone’s book.
The new report says that offshore wind, solar PV and onshore wind could be cheaper than new coal plants between 2022 and 2025.
These dates, while projections and possibilities only, are not that far away.
The direct economics of this may no longer even matter anymore, anyway.
Bloomberg reported earlier in the year that Singapore’s largest bank plans to stop financing coal power after 2021.
There are plenty of other banks that are going the same way.
How far away are bond and equity markets from doing the same thing?
I have no idea.
But coal stocks play no part in my long term investment plan.
The outlook for the whole industry is just too murky.
No 100 baggers here anymore
That doesn’t mean coal companies aren’t profitable with prices at their current level.
But you do have to wonder how much the market will be prepared to pay for these coal stocks stocks.
This is important. s
My colleague Chris Mayer wrote a book on the stocks that returned 100–1 in the US stock market.
There were two main components:
- A stock has to grow its earnings.
- Plus, the market must also place a higher premium on those earnings, too.
For example, a stock could trade on a Price-to-Earnings (P/E) ratio of 15.
Something comes along to give it a big boost…or at least the perception of that happening.
That could conceivably take the P/E to 30 or 100 or any other number.
That will drive the price of the stock up, even if the earnings aren’t growing as fast, or at all.
You get a massive gain in the stock when earnings growth is big and the PE goes big, too.
The ASX, in recent times, shows this in action.
The Age reported back in August that tech darlings WiseTech Global Ltd [ASX:WTC] and Xero Ltd [ASX: XRO] were trading on P/E multiples of 150 and 535 respectively.
That compared to the market average of 18.45.
Here’s why I mention this…
It’s exceedingly unlikely any coal stock will ever carry a high P/E ever again.
There is just too much negativity and pushback against the whole industry, let alone the potential demand destruction from renewables.
That limits how much capital growth you’re going to get off the stock, so why bother?
But the implications of this don’t end in the stock market.
Goodbye royalties and US dollar export earnings
As above, falling demand for coal is — at some point — going to cut out a big chunk of Australia’s export and government revenue.
That’s no small thing either, especially if you happen to live in Queensland.
Coal exports underpin the Australian dollar and the ability of our banks to borrow money offshore.
That’s why it’s important to watch coal, even if you don’t plan on buying any of the stocks.
The decline of coal, especially if it happens faster than we anticipate, is going to play out in a lot of different ways.
It might mean the Queensland government has to cut services somewhere.
It might mean a lower Aussie dollar takes Aussie gold higher.
It might mean the cost of capital for Aussie banks goes a little higher.
Who knows how this plays out?
But the outlook for this major export industry looks increasingly grim on a medium term timeline.
Australia’s politicians would do well to build up a new export industry that can replace it for when the big shift happens.
However, I fear that idea will go the way of my tomatoes — and never feed much more than a few birds.