How Will the End of China's One-Child Policy Affect Coal Miners?

How Will the End of China's One-Child Policy Affect Coal Miners?

On Friday November 15, the Chinese government announced that it would reform its famous one-child policy.

The one-child policy, which was first introduced in 1979, restricted couples who lived in cities to one child. The new reforms will allow couples in cities to have two children if either the husband or wife is an only child.

What it means for the Chinese economy
A big part of real GDP growth is population growth. With the eventual repeal of the one-child policy, this means that China's future GDP growth will likely be stronger.

More children means more demand for food, health care, education, children's products, and housing. More demand leads to more production, which increases GDP.

What it means for coal miners
The eventual increase in demand for housing means more demand for steel. More demand for steel means more business for metallurgical coal miners.

Any pickup in housing in China is significant because China has accounted for almost 50% of global coal demand in recent years.

In a year where the S&P 500 is up 35%, coal miners have lagged significantly. Walter Energy is down 52% year to date. Peabody Energy is off 23% while BHP Billiton shares are down 6% year to date.

While BHP Billiton is the world's largest exporter of coking coal, the company has not suffered as much as the American miners because it has a low cost of production with costs around $110 a metric ton compared to $135 to $145 a metric ton for U.S. producers. BHP Billiton is also very diversified in that it mines other materials such as copper, silver, alumina, gold, nickel, and uranium. This insulates BHP Billiton from low metallurgical spot prices while giving it good exposure to any Chinese rebound. Between the three coal miners, BHP Billiton is the strongest and safest company.

Walter Energy is largely a metallurgical coal pure-play. It has had some major problems over the past year. The company is highly levered with a total debt to equity ratio of 2.87. The high leverage plus the falling metallurgical coal spot price has wrecked havoc on the company's stock. Walter Energy has, however, worked out an extension on its debt at the expense of cutting its dividend. The extension gives Walter Energy some room to lower its costs and get things in order. If there is any significant rebound in China, Walter Energy will likely see its shares rally significantly because it is highly levered and derives most of its revenues from metallurgical coal.

Peabody Energy mines both thermal and metallurgical coal. The thermal coal segment has relatively stable demand because it supplies domestic power plants. The price of natural gas, which competes against thermal coal, has remained relatively flat this year so there is less reason to fear less demand. Peabody Energy is less levered than Walter Energy with a total debt-to-equity ratio of 1.32 and it does not derive as much percentage of revenue from metallurgical coal. The company will not benefit as much from any Chinese rebound as Walter Energy, but is a much safer play. According to analyst estimates, the company is likely to be profitable next year.

The bottom line
The news that China will end its one-child policy will not add to the bottom lines of any companies in the short term. It will, however, likely increase the demand for metallurgical coal in the long term. Since the stock market typically looks ahead, the news is another reason to be less pessimistic about the metallurgical coal sector.

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