Bullish on Coal: Contrarian Dream or Nightmare? (ANR ACI, CNX, BTU, JEF, AAPL)

March 22, 2013 by Jon C. Ogg

coal trainIf there is one great American industry that has been left for dead, it is the U.S. coal industry. With every possible battle to fight from pollution and environmental concerns to mine safety and to changes in how energy is produced, the coal companies face constant headwinds.

Coal is also a highly political issue, and it is no secret that the current administration would rather see solar power or just about anything else but coal be the fuel driving America’s electricity. Given inexpensive shale gas and pending environmental rules, the domestic coal market will probably never be larger than 90% of the levels seen in the past decade.

While this may sound disastrous, the metals and mining team at Jefferies Group Inc. (NYSE: JEF) believe there is a positive investment case to be made for the surviving producers. In a new research report, the analysts highlight the stocks that can be bought and give some reasons why investors may need to take a contrarian stance.

The team at Jefferies cite the fact that all four major coal companies have decades of reserves. As a result, there is little need to spend money on exploration. Plus, much of the needed capital already has been sunk. Therefore, even at current coal prices, they expect the coal industry to generate substantial levels of free cash flow for years to come. In addition they believe there is upside to current coal prices.

In their current report, the analysts at Jefferies recommend the purchase of all four of the following major coal companies. They are trading at levels not seen in years.

Based in Bristol, Va., Alpha Natural Resources Inc. (NYSE: ANR) is a leader in metallurgical coal mining. That is the coal that is used in industry to make steel and other products. The Jefferies price target for the stock is $13. Based on current trading levels, that would represent a 50% stock move for investors. The Thomson/First Call price target is close at $12.

Arch Coal Inc. (NYSE: ACI) is also a stock to buy at Jefferies. With 32 mines in operation, Arch Coal is another large producer of steam and metallurgical coal, and it has an estimated 5.5 billion tons of proven and recoverable reserves. It is trading in the mid $5 range, and the price target is $12. The Wall St. consensus target for Arch Coal is $7.75. Investors may recall that this stock traded as high as the upper 70s in the summer of 2008.

Pennsylvania-based CONSOL Energy Inc. (NYSE: CNX) has the distinction of being in both the coal and the natural gas business, a consideration for investors looking to be involved in the coal trade but like diversification. With large coal and natural gas reserves, CONSOL has a price target of $46. The consensus estimate is $40.

Rounding out the four major U.S. coal producers and stocks to buy is another former high flyer, Peabody Energy Corp. (NYSE: BTU). Trading over $80 back in 2008, Peabody Energy is estimated to have more than 30 years of quality reserves. The price target is $40 at Jefferies,while the consensus target is $33.75.

Investors looking for anecdotal reasons to buy these stocks should recall the horrific Fukushima nuclear disaster in Japan two years ago. In the wake of that event, Japan has shut down all but one of its nuclear plants. Germany has announced plans to shut down all of its nuclear plants by 2022. In addition, some aging nuclear plants in the U.S. are expected to be shut down. Some energy source is needed to replace that electricity output. Cheap coal is a huge alternative as natural gas climbs back towards $4.

Large, growing countries like China and India use a tremendous of amount of energy and both rely on thermal coal to produce electricity. In China, more than 70% of domestic electricity generation is from coal-fired power plants, while India uses thermal coal for about 60% of its electric power supply. Economic recovery in Europe and Japan, both of which are large importers of thermal coal, will only increase demand.

Every 10 years or so, investors get to pick through the rubble of a shattered industry. After the tech collapse in 2000, names that had traded over $100 became single-digit stocks and were assumed to be going to zero. One stock that was in the single digits then was Apple Inc. (NASDAQ: AAPL). The stock ultimately went over $705 last summer. There is absolutely no guarantee that will ever happen with coal stocks, but there is also no guarantee they will go out of (or stay in) business.

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