RD's Picks

Coal stocks, including Arch, have been strong over the course of this difficult market. A review of coal prices quickly explains why. According to a recent weekly NYMEX report issued by the Energy Information Administration, the near month price for Central Appalachian coal has climbed from a little over $44 per ton a year ago to over $138 per ton as of 27 June. In the same time frame, ACI stock has roughly doubled. At these coal prices, Santa may have to find something else for bad kids' stockings.

Last week, coal stocks got hit with a big correction on a drop in European coal prices. On 2 July, ACI dropped from just under $75 at the open to close a little above $62 per share. That was followed by an upgrade from Citigroup on the 3rd.

The key to Arch, and other coal companies, as investments going forward is whether the drop in European prices was a short-term market move or a signal of longer term pricing weakness.

ACI fundamentals still look strong. Despite a trailing PE of over 40, the stock sells for only 11 times 2009 estimates and those analyst estimates have been climbing steadily over the past few months.

The Energy Information Administration posts a lot of useful information on their coal data site. The latest International Energy Outlook 2008 Highlights predicts increasing coal demand going forward, largely due to projected increases in world electricity demand.

I don't think the drop in European prices marks the end of strong coal demand. World electricity demand is still growing and that means coal and natural gas demand will keep growing for the foreseeable future. Another potential source of coal demand is coal-to-liquid conversion for transportation fuels. I don't know what oil-to-coal price ratio makes that economically feasible, but if we get there coal companies would definitely benefit.

In addition to risk of a recession driving down coal demand, Arch faces cost risks. Mining is an energy intensive operation and those rising prices will hurt if they can't be passed on.

Rising labor costs also present a risk. If strength in the coal industry continues, labor is likely to push for pay increases to participate in the good times. If coal price hikes match or outpace costs, coal companies do well; if not, margins get squeezed.

Alternative energy presents a long-term risk to coal. If increases in wind, solar, and other renewable energy sources can grow faster than electricity demand, demand for coal would be reduced.

Energy stocks in general have been doing well in this tough market. Although there's no way to know for sure if that will continue, I don't see any reason for energy companies to start underperforming. Given that strength, having some energy exposure in a portfolio makes a lot of sense, and Arch is a good way to get that exposure.

Comments: View Comments |  Monday July 7, 2008  |  Stocks: ACI,