Taking a Shot at Massey Energy (MEE)

Everybody knows about the tragic accident.  Just two weeks before the incident, Goldman Sachs went significantly bullish on all coal miners and I posted that when we initiated April bull put spreads on PCX and MEE.  Both are still open and I expect both of them to expire worthless.  


Given this tragic accident, shares of MEE have significantly underperformed relative to all other coal miners.  For some, this is an opportunity to sell.  For me, this is an opportunity to buy because sooner or later investors will return back to strengthening fundamentals and leave the tragic incident behind.  


Here is the latest note from Credit Suisse:



"We send our deepest sympathies to all those impacted by the Upper Big Branch tragedy yesterday. Unfortunately we are obligated to publish a research report given the significance of the tragedy to MEE shareholders and the coal industry in general. 


The numbers side - UBB produced 1.2m tons of high vol met coal, which we estimate would contribute ~$20m to 2010 EBITDA (or $0.15/sh in 2010 EPS), and as much as $100m in 2011 and 2012 (or $0.73/share in EPS), or ~10% of our total EBITDA estimate in 2011 and 2012. Given the magnitude of the tragedy and the uncertainty as to the actual cause, in our view it is unlikely the UBB mine will reopen in the near-term. However, clearly too early to forecast duration of shutdown. 


Initial thoughts: Stock Implications - 1. Clearly this is a tragic reminder of the inherent execution risk for MEE and US coal producers in general. This will likely manifest itself in a return to the historic EV/EBITDA multiple discount for MEE vs the peers (historically ~20% on 2-year forward EBITDA, vs. a 7% premium currently). 2. Uncertainty about potential liability/litigation, and future permitting/regulatory challenges create an overhang for MEE shares until clarity emerges. 

Initial thoughts on industry implications - 1. Regulatory scrutiny will increase significantly - unfortunately this is not the first time accidents such as this have happened, and each time previously the after-effect was meaningfully higher regulatory costs and increased challenges/delays in obtaining permits, particularly for smaller CAPP producers. 2. Unfortunate reality is this tightens up an already tight met coal market, taking another 1m tons of annual met output (UBB is unlikely to re-open anytime soon) out of a market that is already short."

Technically, the stock is setting up nicely here closing in on rising support line that has been intact since Oct 2009.  At most, I see further pull back to $43.50, but then I expect the support to hold.  Volume is concerning here a bit as many hard core longs may have already exited, so the stock may just not do much here.

I am doing the following calendar spread:

- Buy to open July $50 calls
- Sell to open April $50 calls

I just filled the order for $3.10 net debit.  The play here is exactly the same as AAPL and V.  That is, on a run back above $50, I will roll April $50 calls to May $55.  If it doesn't run, I will keep selling front month $50 calls to keep bringing the cost down of July $50 calls.

The primary risk here, as CS highlighted above, is that the mining operation at this particular mine may remain closed for a while.  Plus, new government regulation may come down, which has been common with the new administration anyway.  But as long as the stock holds $43.50, I think it is worth a shot back to the upside.

I like the odds.  Good luck.