The smart money is buying CONSOL Energy Inc. (NYSE:CNX). According to SEC filings, Southeastern Asset Management increased its position from 44,949,771 shares at the end of Q1 to 48,212,227 shares, good for 21.1% of Consol’s float. In addition, David Einhorn’s Greenlight Capital increased its position from 20,583,070 shares at the end of the first quarter to 29,609,565 shares. Because of their recent buys, the two institutions now own more than a third of Consol Energy’s common shares. The two institutions have been buying while Consol Energy’s stock has been falling. Because of weak coal and natural gas prices, Consol Energy’s stock is down by 47% year-to-date and by 55.87% in the last 12 months.
We mention the hedge fund activity around Consol Energy because following hedge fund activity can generate alpha. Our research shows that the 15 most popular small-cap stocks among hedge funds have outperformed the market by nearly a percentage point per month between 1999 and 2012. We have been forward testing the performance of these stock picks since the end of August 2012, and they managed to return more than 123% over the ensuing 2.5+ years and outperformed the S&P 500 Index by over 66 percentage points (read the details here).
Although CONSOL Energy Inc. (NYSE:CNX) has transformed itself from a coal company to a hybrid natural gas and coal producer, coal still makes up 57.6% of Consol’s revenues. Due to the declining coal prices, many coal companies have declared bankruptcy or are thought to be pondering bankruptcy. Natural gas prices have also fallen considerably due to an industrywide surplus.
The low natural gas and coal prices are negatively affecting even the strongest companies in the sector. Consol Energy recently warned that its Q2 earnings will be worse than expectations, with management warning that the company will report a loss from operations in the second quarter despite meeting its total production guidance for the coal and E&P natural gas divisions. In addition, management also warned that Consol will take an asset impairment charge to reflect lower commodity prices.
While an asset impairment charge will decrease EPS and lower book value, an asset impairment charge is not operationally negative because it is not a cash expense. If energy prices recover, Consol’s assets will be marked up again. Consol Energy’s Q2 loss from operations is more concerning. A loss from operations means that Consol Energy is bleeding cash. While Consol Energy isn’t as leveraged as Chesapeake Energy Corporation (NYSE:CHK) and Southwestern Energy Company (NYSE:SWN) are, the cash bleed means that Consol Energy has a finite lifeline before its liquidity runs out. Fortunately, Consol’s management hopes to address this issue by outlining a plan for the company to become free cash flow positive over the next 18 months. As long as the company is cash flow positive, Consol Energy will be in business.
Although it is a falling knife, we believe that Consol Energy is a good long-term holding. We are bullish on natural gas in the long run, as LNG exports will increase demand and industry capital expenditure cuts will reduce supply. If natural gas prices rise to $4-$7 per mcf, Consol Energy will be a fantastic stock to own at current price levels.
We like how the smart money is adding as well. David Einhorn is perhaps the most astute investor in energy right now, having correctly called crude’s decline last year and the fracking decline this year. Given that he is bearish on many energy plays, it stands to reason that Einhorn’s bullish energy pick has strong investment merit.
One such strong investment merit could be a potential sale. According to news sources, Southeastern Asset is pushing CONSOL Energy Inc. (NYSE:CNX) to spin off or sell its natural gas business to unlock shareholder value. Southeastern Asset believes that a sale of the division could receive a bid that is more than Consol’s current market capitalization. Given the short float of over 11%, a sale or spin-off would generate a considerable short squeeze as well.
Disclosure: None
