The world of penny stocks is a minefield.
The majority of penny stocks available at any given time trade over the pink sheets or over-the-counter bulletin board exchanges — and they’re filled with all sorts of issues. Many aren’t viable companies. Some are outright frauds. Some are being played by pump-and-dumpers. None of them are required to provide financial information, and many don’t.
In short, if you needed a blanket rule to apply to investing, you could do well by never touching penny stocks.
Still, every once in a while, a real business does end up falling to penny-stock status. These are real businesses with actual assets, real employees, even a listing on a real exchange like the NYSE or Nasdaq. Obviously, this doesn’t happen unless the company has fallen on hard times, but you still can at least evaluate these businesses because they’re real, and because as long as they’re on these major exchanges, they’re obligated to report their financials.
And in these rare cases, it’s worth at least scrounging around to see if there’s a cheap rebound to be played. Take, for example, a pair of “newly minted” penny stocks — coal stocks Arch Coal Inc (NYSE:ACI) and Alpha Natural Resources, Inc. (NYSE:ANR).
Coal Stocks: Down, But Not Out
As we’ve documented multiple times before, the coal industry has faced a dual threat of rising environmental regulation and falling demand due to relatively low natural gas prices. These two factors have basically tied the hands of many utilities, which continue to close coal-fired power plants and open nat gas-powered plants instead.
And in terms of coking (steel-making) coal, lower steel demand and subsequently lower steel production have pretty much done the same amount of damage.
With that said, it’s easy to see why industry stalwarts like Peabody Energy Corporation (NYSE:BTU) have fallen on hard times. But why have ANR and ACI been beaten so badly that they’ve fallen below the all-important $1 level?
Debt. A lot of debt.
Alpha Natural Resources has packed on $3.7 billion in debt, much of that at the expense of buying Massey Energy just as the market for coking coal peaked. Arch is saddled with more than $5.12 billion, also coming from various acquisitions made during periods of higher coal prices.
Now consider that neither ACI nor ANR is profitable in the current low-price environment for thermal and metallurgical coal, and you can see why the two coal stocks are being priced for bankruptcy.
But the thing is, the odds of both actually filing for bankruptcy is quite low. There’s a chance, but not much of one.
The reason why both coal stocks could survive the downturn is on the rest of their balance sheets. Both actually have some pretty decent liquidity to play with. ACI has roughly $1.31 billion in liquidity, of which about $1 billion is cash and short-term investments. Likewise, Alpha has about $2.3 billion in liquidity, with $1.1 billion in cash and short-term investments. Both have also reduced their capital expenditures and taken other measures to control cash burn; ACI recently suspended its dividend, while ANR has closed mines.
Those moves help extend the runway in terms of cash needed to function, and given these coal stocks’ liquidity, they still have a few more years to wait for a turnaround in coal prices.
Also helping the matter: Their hefty debts don’t need to be refinanced anytime soon. Bankruptcies usually happen when a firm can’t either refinance or pay off their debt when it comes due. The earliest debt that ACI needs to deal with comes due in 2018; for ANR, that year is 2017. Two or three years doesn’t sound like much time, but it’s a lifetime on Wall Street.
Not to mention, we’ve already seen at least something of a coal rebound. ACI has at least been able to reduce losses, and overall, pricing for Powder River Basin coal as well as some other grades have risen recently and still are profitable against natural gas. Additionally, rising coal shipments and exports have helped on the revenue front.
These Penny Stocks Have Better Odds
Yes, ACI and ANR are technically penny stocks, but investors are getting a lot for the 80 cents or so per share that they trade for. Consider it a call option on the fate of coal.
If Arch Coal and Alpha Natural survive, refinance their debt in a couple of years and coal rebounds even slightly, you could very well double or triple your money in a simple relief rally. At the same time, the downside is pretty much limited, at least in the near-term. Is there risk in ACI and ANR? Absolutely. But we’ve hit the points where the rewards far outweigh that risk. These penny stocks are worth a speculative play, and I’ve already put my money where my mouth is.
As of this writing, Aaron Levitt had recently bought shares of ACI and ANR.
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