Yes, You Should Still Buy Coal Stocks

by Tim Melvin | August 30, 2013 11:40 am

As a value and distressed investors, my eyes have naturally focused on the materials sector in the past couple of years. In fact, one sector that really has my attention is coal.

Coal is dirty, nasty stuff — the single dirtiest fuel source we have. Environmentalists despise the stuff and politicians love to vilify the coal industry. We have seen more regulations aimed at forcing industry and utilities towards cleaner natural gas and the coal business has suffered mightily the past few years.

But the other truth about coal is that it is also one of the most plentiful and cheapest energy sources on the planet.

In spite of all the regulations and noise, about 40% of electricity here in the U.S. comes from coal-fired power plants. Sure, coal usage has been declining … but not exactly at a blistering pace in spite of the alarmist headlines. Total coal consumption is down so far this year, but some sectors of the economy including transportation and food production facilities have actually increased their usage.

The bottom line: Coal may be unpopular, but it is not going away. This is especially true given the fact that the coal industry directly employed around over 90,000 people[1] and supported nearly 170,000 jobs[2] in 2011. Since lots of those workers are economically weak areas of the country, do not be surprised to see the political pressure on the industry ease up as we go into the next election.

The other dirty truth about coal: We can posture and regulate coal as much as want … but whatever we don’t burn, the rest of the world will. Emerging nations in search of faster economic growth need cheap energy and, in many parts of the world, the cheapest energy source is coal.

The situation is improving for U.S. coal producers too. A recovering economy is going to create more energy demand and that is good news for coal. A rebound in the steel market will also be good news for the long-term outlook for coal demand and pricing. Plus, we have seen some marginal miners go bankrupt and larger companies shave reduced output. That has allowed coal stockpiles to be worked down to reasonable levels. And a colder winter in the U.S. could see a spike in demand and pricing for coal miners.

With that in mind, don’t be afraid to bet on coal stocks.

I have owned shares of Arch Coal (ACI[3]) for some time now. While I am backwards on the positions right now (my cost is close to $6 a share), I am comfortable holding my shares. The stock is trading at around half of tangible book value and that’s cheap for the second-largest coal company in the U.S. If the company just survives — and I think it will — the stock should more than double sometime in the next few years.

Peabody Energy (BTU[4]) is the largest coal producer in the states and the largest private-sector coal company in the world. The company is well-positioned in the Powder River area, which already produces nearly half of the country’s coal. Peabody also has Australian operations that can serve the faster growing Asian regions, including China.

The stock is trading right at tangible book value, though, so I would prefer to see a little sell-off in the shares before buying the stock. Or I would sell the December $15 puts as a way to back into the shares cheaper than the current quote.

All in all, coal is not going away, no matter how much the politicians and environmental groups protest. Neither are the coal miners and coal stocks, so long-term investors should have some of the nasty stuff in their portfolio.

As of this writing, Tim Melvin was long ACI.

Endnotes:
  1. over 90,000 people: http://www.nma.org/pdf/c_employment_state_region_method.pdf
  2. nearly 170,000 jobs: http://www.nma.org/index.php/press-releases/press-releases-2013/848-u-s-coal-exports-help-fuel-economic-recovery
  3. ACI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ACI
  4. BTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=BTU

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