Coal Stocks Above 2007, But Valuation Risks Remain (ACI, BTU, CNX, FCL, MEE, KOL)

In the past 52-weeks, the stock price of five large coal companies has risen anywhere from 50% to nearly 250%. But that’s still between 27% and 42% below annual highs that the companies reached in June. Peabody Energy (NYSE:BTU) has fallen 27% from its 52-week high, Arch Coal (NYSE:ACI) and Massey Energy (NYSE:MEE) have both dropped 32%, Foundation Coal (NYSE:FCL) has dropped 34%, and CONSOL Energy has lost 42%. In late June, Massey was up nearly 400% and CONSOL was up more than 200%.  These numbers may be slightly different based upon UBS’s upgrade to coal stocks this morning, but you will see the general idea below.

The last month and a half have cost shareholders in these companiessome significant money even if you factor in today’s pop. And thattrend looks like it could continue if energy prices don’t keep rising.Foundation’s PE ratio for the trailing twelve months is a whopping210.51, and its forward PE is 10.09. The other four are not asdramatic, with current PE ratios around 50 and forward PE ratios alsoaround 10.

Is coal really the next dot.com?  Not likely, but that doesn’t meanthat the coal companies don’t have some problems. Foundation actuallyreported a net loss of $4.4 million for the second quarter of 2008,even though prices were higher in every region. The company’s bigproblem came from the Powder River Basin of Wyoming, where 68% ofFoundation’s coal was produced. The average price per ton of PRB coalwas $10.05, less than half the company’s overall average of $23.82,which included Appalachian and Illinois coal that is priced four to sixtimes higher per ton.

Costs and capital expenses are going to hit coal companies with a largepercentage of assets in the Powder River Basin. Rail lines to carry thecoal to east and west coast markets are critical to continuing growth.Just recall the situation this past spring when Midwest floodingessentially stranded PRB coal from eastern markets.

Demand for coal will not decrease. After all, nearly 50% of USelectricity is generated from coal-burning power plants, and demand forelectricity is growing quickly. But coal companies also have to facetightening emissions standards which make natural gas and renewableslike wind and solar more attractive. Even nuclear power generation mayre-enter the competitive picture. Current valuations of coal companieswill very likely continue to fall, but over the medium term, nothing isgoing to replace coal and that fact alone should keep coal burningbright.

Even with coal stock gains pushing up the Market Vectors Coal ETF (NYSE: KOL), you can do a glass half-full or half-empty argument.  The ETF is up over 3% this morning at $45.50, which is down roughly 25% from the $60.30 high and up almost 40% from its lows of $32.59. When you consider that this ETF just launched in January of 2008 and we are only in August, you realize that volatility is this dirty commodity’s middle name.  With the volatility of coal prices being so high and with some companies hedged and others unhedged, pick your coal stocks carefully.

Paul Ausick
August 21, 2008