In 1998, the tobacco industry reached an inflection point. The Tobacco Master Settlement Agreement (MSA) imposed vast marketing restrictions and ongoing healthcare payments onto the tobacco companies, resulting in a 60% plunge in industry leader Philip Morris (now known as Altria). Yet contrarians made generational wealth as improving sentiment drove two decades of soaring dividends and buybacks. Today, coal mirrors tobacco’s bottom—could it stage a similar comeback?
The Villainization of King Coal
Coal firms now face the hostility tobacco endured in the 1990s. Derided as the dirtiest fossil fuel, coal has become a target of environmentalists and ESG-driven divestment. President Biden aims to eliminate coal from electricity generation by 2035. Major banks increasingly deny financing to coal firms, starving them of growth capital, much like tobacco companies following landmark litigation and settlements.
Yet global coal demand continues climbing, with Asian juggernauts like India and China accounting for 75% of current usage. Why? Coal remains the most affordable and reliable energy source for electricity and steel production in developing economies. Barring a swift technological revolution, coal shall play an indispensable role globally for decades to come, even if Europe and North America eventually decarbonize.
Just as tobacco persisted through its existential crisis, coal will endure international hostility in some form rather than disappear entirely. While contrarian investors two decades ago could not predict tobacco’s resilience, coal pessimism today similarly fails to reflect on-the-ground reality.
We've Seen This Before
Tobacco and coal share common traits that suggest underpriced upside potential. Both operate cash generative businesses with minimal ongoing investment once infrastructure like mines or manufacturing is in place. Despite commodity price cycles for coal, these lean operations enable substantial buybacks and dividends over time.
Additionally, tobacco and coal have become capital starved from institutional avoidance despite consistent end market demand. Even though this policy risks suppressed valuations, global consumption marches higher regardless. Just as tobacco demand fell in the West but climbed in emerging markets, coal demand wanes across Europe and North America today while Asian giants exhibit insatiable appetite.
Buybacks: The Hidden Catalyst
With headwinds capping valuations, coal firms have turned to share buybacks. By acquiring heavily discounted shares, companies can generate significant per-share growth even if stock prices languish. Just look at Alpha Metallurgical Resources, which has repurchased up to 20% of its stock annually in recent years. If coal mirrors tobacco’s history, buybacks could drive enormous shareholder gains over the coming decade.
For example, Altria repurchased massive amounts of stock at extreme valuations after the 1998 settlement. An investor who bought shares around the year 2000 bottom had received an over 38% annual dividend yield by that point. Altria subsequently delivered over 20 years of uninterrupted dividend growth while continuing to buy back stock. Coal firms today have years of runway for similar programs given their discounted valuations if commodity prices hold at profitable levels.
Risky Business
There are of course differences between the two industries that change the risk profile for coal.
First, tobacco witnessed secular volume declines while coal demand is rising globally. This is good for coal. đź‘Ť
However, tobacco has pricing power due to strong brand loyalty that coal does not have. Coal’s status as a commoditized price taker means buyers care more about cost than supplier name. This is bad for coal. 👎
Additionally, tobacco’s cash flows are far more predictable given brand strength and consistent pricing ability. In contrast, coal’s margins fluctuate cyclically with underlying commodity markets, bringing added macroeconomic volatility risk. This is also bad for coal. 👎
How To Gain Exposure with Ease
For investors daunted by picking individual coal stocks, the Range Global Coal Index ETF (Ticker: COAL) offers a simple solution. Newly launched in January 2024, this fund tracks an index of global coal companies involved across areas like production, exploration, transportation and distribution. Buying the ETF provides exposure to the industry's upside while diversifying away individual company risks.
Conclusion
Coal equities today reflect valuations last seen during tobacco’s existential crisis. For courageous investors with decade-plus time horizons, these underpriced coal firms represent a compelling, if contrarian, opportunity. The parallels to tobacco’s own mispricings in decades past are uncanny. Buoyed by Asian coal demand and record buybacks, perhaps coal can stage its own surprising revival just as Big Tobacco eventually did. As in any commodity, risks abound, but coal’s risk-reward ratio warrants a calculated bet.