Stock Analysis & Ideas

Hydropower is Out; Coal and Battery Power are In. Check Out BTU, ARCH, and RUN Stocks

Story Highlights

Droughts, along with persistent heat waves across several countries, have impacted the supply of hydropower. This has led to increased demand for coal and battery storage systems. We’ll discuss how two coal producers and a solar battery company are benefiting from the hydropower shortage.

Rising fuel costs triggered by the Russia-Ukraine war and climate change have pushed governments across the world to accelerate the transition to renewable sources of energy. However, the supply of hydropower, one of the key renewable sources of energy, has been severely hit by drought in several regions in China, the U.S., and Europe. The dearth of hydroelectricity implies strong prospects for coal companies like Peabody Energy (NYSE:BTU) and Arch Resources (NYSE:ARCH), and solar and battery storage companies, including Sunrun (NASDAQ:RUN).

Reliance on Coal, Battery Storage Rises Amid Hydropower Shortage

The drought in China has dried up several rivers, including parts of the Yangtze River, the country’s longest river, and has impacted hydropower generation. Several industries are facing severe production disruptions due to power shortages.

Meanwhile, high temperatures combined with drought have exacerbated the energy crisis in Europe. In the U.S., California, which is facing a severe shortage of hydropower due to drought, is urging customers to conserve energy to reduce the strain on its power grid amid a persistent heat wave.

The dependence on coal has increased due to hydropower shortage and soaring natural gas prices. As per the International Energy Agency (IEA), global coal consumption will rise by 0.7% to 8 billion tonnes in 2022, assuming the Chinese economy rebounds as anticipated in the second half of the year. While the percentage increase from last year seems small, the IEA points out that the 2022 global coal demand would touch the record levels seen in 2013. Also, the IEA expects coal demand to likely increase further in 2023 and touch a new all-time high.

Robust coal demand has fueled a notable jump in coal prices this year and has led to phenomenal growth in the earnings and cash flows of several coal companies, as discussed later in this article.

Meanwhile, the IEA also estimates investments in battery energy storage to reach record levels and more than double to nearly $20 billion in 2022. Battery energy storage systems store energy from renewables, like solar and wind, and release it when needed to respond to electricity demands.      

Let us now discuss three companies that are gaining from the hydropower shortage.

Peabody Energy (BTU) Stock

Peabody is a leading producer of metallurgical and thermal coal. It had ownership interests in 17 active coal mining operations in the U.S. and Australia as of June 30, 2022. The coal upcycle helped Peabody generate earnings per share of $2.54 in the second quarter of 2022, compared to a net loss per share of $0.28 in the prior-year quarter. Revenue jumped nearly 83% to $1.32 billion, driven by higher realized prices across all the segments.

Despite impressive year-over-year growth rates, Peabody lagged analysts’ expectations due to several headwinds, like rail availability in the U.S. and the impact of weather as well as COVID-related absenteeism on Australian operations.

While Peabody expects strong performance in the second half of the year driven by strong demand, the company revised its full-year guidance to reflect the impact of severe July rains in Australia on the Q3 numbers.

Is Peabody Energy Stock a Buy?

Following the Q2 print, B.Riley Financial analyst Lucas Pipes trimmed his price target for Peabody stock to $28 from $31 but maintained a Buy rating.

 On TipRanks, Peabody Energy has a Moderate Buy consensus rating based on two Buys versus one Hold. The average Peabody target price of $30.67 implies 31.5% upside potential from current levels. BTU stock has already skyrocketed 132% year-to-date.

Arch Resources (ARCH) Stock

Arch Resources provides metallurgical and thermal coal from mines located throughout the U.S. to steel producers, utilities, and industrial customers worldwide. Thanks to soaring coal prices amid a strong demand backdrop, Arch’s revenue surged 152% to $1.13 billion in Q2 2022 and surpassed the Street’s expectations. Furthermore, Arch’s EPS jumped to $19.30 from $1.66 in the prior-year quarter.

However, despite the impressive year-over-year improvement, Q2 EPS fell short of expectations. The second-quarter bottom line was impacted by persistent rail service challenges, higher costs due to inflation, and “isolated geologic issues” in the company’s core metallurgical segment.

Meanwhile, amid favorable business conditions, Arch announced a new capital allocation plan earlier this year, under which it would return 50% of the prior quarter’s discretionary cash flows to shareholders.  The company announced a dividend of $6.00 per share (which includes a fixed component of $0.25 and a variable component of $5.75), which is payable on September 15, 2022.

Arch has also used its strong cash flows to bring down its debt by $417.5 million, or approximately 70%, since the beginning of this year.

Is Arch Resources a Buy?

Following the Q2 results, B. Riley’s Lucas Pipes slashed his price target for Arch Resources to $221 from $234 and reiterated a Buy rating. Pipes noted that the company’s Q2 adjusted EBITDA fell short of his estimates. However, the analyst opined that he would take advantage of the pullback in the stock as management showed “a strong preference for buy-backs” and increased their share buyback authorization to $500 million.

Overall, ARCH earns a Strong Buy consensus rating based on four unanimous Buys. The average ARCH stock price target of $196.50 implies nearly 42% upside potential. The stock has surged nearly 52% so far this year.

Sunrun (RUN) Stock

Sunrun is one of the leading providers of home solar, battery storage, and energy services in the U.S. The company recently announced that it delivered over 80 megawatts (MW) of stored solar energy capacity daily from more than 17,000 customer batteries to ease the strain on California’s electric grid.

This emergency energy capacity was provided during the statewide Flex Alert, which is a call for consumers to voluntarily reduce their electricity usage to ease the strain on the power grid. In July, Sunrun announced that it is well-positioned to mitigate the severity of grid shortages and blackouts across the country by dispatching its installed battery capacity of over 150 megawatts.

What Is the Target Price for Sunrun?

Last week, Bank of America Securities analyst Julien Dumoulin-Smith increased the price target for Sunrun stock to $55 from $40, and also boosted the price target for Sunnova Energy (NOVA) as she views them as clear winners of the Inflation Reduction Act.

Smith explained, “We believe that those companies directly receiving the government incentives are the clearest financial beneficiaries of the package, which is in many ways are most apparent for the resi solar installers, specifically, RUN and NOVA, who retain value of originated assets and the value of the tax credit in lease based products.”

Overall, Sunrun scores the Street’s Strong Buy consensus rating based on 13 Buys and two Holds. At $47.07, the average Sunrun price target suggests 22.4% upside potential. Shares have advanced 12% year-to-date.

Final Thoughts

The shortage of hydropower has favorably impacted the demand for coal and battery power. The steep rise in coal prices might not be sustainable in the long run due to the shift toward clean energy resources. However, the long-term demand for solar energy remains solid as the U.S. and several other countries are offering incentives for the increased adoption of solar power, thus driving growth for companies like Sunrun.

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