Buffett, Burlington and Coal: 5 Stocks to Consider

by: Investment Underground

Berkshire Hathaway's (NYSE:BRK.A) Warren Buffett recently took the opportunity to visit Arch Coal’s (ACI) facilities in Wyoming. He was prospecting coal on a detour of his tour with Bill Gates to obtain pledges from world billionaires.

Buffett's purchase of the entirety of Burlington Northern Railroad (BNI) is a good segue into coal. Buffett first noted that Gates was ahead of him to identify railroads as a good long-term investment due to this commodity. And before Buffett, Alleghany Insurance (NYSE:Y) was one of the first to identify commodities and commodity shipment as a very profitable venture over the long-run.

So will Buffett dive into the coal-mining sector? Here are a few coal names that could produce long-term shareholder value in the years ahead…

  1. Arch Coal (ACI): ACI is the second largest coal producer in the US and operates mines primarily in the Powder River Basin, an oligopoly-controlled coalfield with easy-to-mine, low-sulfur coal, allowing miners to extract at one-fifth the cost of industry peers in the Central Appalachian region. Because of its excellent position in the industry, Arch has built a small moat for itself in an industry with a bright long-term future, as Asia continues to demand this commodity, driving prices upwards for all producers (even those that don't directly supply to Asia like Arch). From a valuation standpoint, Arch appears to be trading a roughly fair value at the time of writing. Should Arch's gross margins per ton increase in 2011 on the back of rising coal prices, fair value may approach the mid-40's on a per share basis.
  2. Peabody Energy (BTU): Peabody also operates primarily in the large, western mines of the Powder River Basin. The company holds some developed coal interests in Australia as well. Both China and India are likely to be huge coal importers in the near future, which was likely part of Peabody's plan in developing its Australian mines. Our fair value estimate for Peabody is in the $53 to $58 range.
  3. Consol Energy (NYSE:CNX): This extremely profitable coal miner has recently funneled resources towards the natural gas production space. Specifically, the company spent $3.5 billion to buy Dominion's (NYSE:D) natural gas assets. In our opinion, this is a smart move. The company and its subsidiary CNX Gas have a healthy balance sheet and excellent cash flows, which they're effectively using to fund gas-drilling programs in the Appalachian wells, coalbed methane and the Marcellus shale. Depending on coal and natural gas prices, per ton operating margins and also the threat of new carbon dioxide emission laws, Consol appears to be undervalued at the time of writing. Shares could trade in the north of $55 with tailwinds from commodity prices.
  4. Alpha Natural Resources (ANR) With its acquisition of Foundation Coal, ANR is one of the largest coal miners in North America. The company extracts, processes and markets metallurgic and steam coal everywhere from Colorado to the Central Appalachian region to the Powder River Basin. Should metallurgic prices remain high into next year, ANR will be in a very solid financial place, providing investors with an opportunity for above average returns.
  5. Rio Tinto PLC ADR (NYSE:RIO) If you want to play China's increasing desire for king coal, Rio Tinto could be a good bet. This global miner possesses an "A-list," low-cost asset base, extracting a variety of minerals and commodities including gold, alumina, coal, iron ore, copper, diamonds and other industrial minerals. This makes the company a good play on global commodity needs and high global commodity prices. Fair value on a discounted-cash-flow basis is in the $75 range.

Curiously, Kiewit Mining Group (a subsidiary of Omaha-based Kiewit & Sons.) has operations in the Powder River. This is the same Kiewit entity out of Omaha for which Walter Scott, Jr. was chairman. Scott currently sits on the boards of Berkshire and subsidiary Burlington Northern and may influence Buffett's decisions regarding a business stake in this area.

Disclosure: I am long BRK.B.

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