The Case for High Sulfur Coal Stocks (ARLP, BTU, CNX, FCL, MEE)

In the WSJ's Heard on the Street column today (paid sub. req'd), Gregory Zuckerman lays out the argument for Consol Energy and other high sulfur coal producers. Key points:

1. High sulfur coal was previously undesirable due to pollution caused when burning it. But many electric utilities have installed "scrubbers" which remove sulfur fumes.
2. Once the pollution problem is removed, high sulfur coal is more economical than low sulfur coal because it is frequently located closer to power plants and burns hotter.
3. The most obvious stock beneficiary is CONSOL Energy Inc. (NYSE: CNX), which get about two-thirds of its coal from Northern Appalachia, a high sulfur region. CNX is the second largest coal producer by revenue. Utilities Duke Energy (DUK) and American Electric Power (AEP) are already starting to use high sulfur coal from CNX.
4. Consol trades at about 17x 2006 estimated earnings and 13x 2007 estimated earnings.
5. Peabody Energy Corp. (BTU), the largest coal producer, trades at a forward estimated 2006 P/E of 27 and 2007 estimated P/E of 17.
6. Other stock plays on high sulfur coal: Foundation Coal Holdings Inc. (FCL) and Alliance Resource Partners LP (ARLP).
7. The switch to high sulfur coal could hit some non-high sulfur coal producers such as Massey Energy (MEE).

Quick comment: Other coal stocks not mentioned in the article include Arch Coal (ACI), Alpha Natural Resources, Inc. (ANR), BHP Billiton (BHP), Headwaters Inc. (HW), Westmoreland Coal Company (AMEX: WLB), and Chinese company Yazhou Coal Mining Co. (YZC).

Comments

[Frank Li]

Notes from the Ira Sohn dinner in May 2007 on coal stocks. The notes were taken in real time, and may contain transcription errors:

<blockquote>
<b> Wilbur Ross, Jr. - WL Ross &amp; Co.</b>

- 33% decline in the price of coal in 7 months.
- Sudden unanticipated drop in demand in early 2006 – mild weather.
- Exacerbated by marginally cheaper Nat Gas.
- Utility industry inventories grew while production costs grew.
- Difficult geological conditions increased safety measures.
- Market coming back into balance.
- Lower production and improving utility demand.
- EIA forecasting 1.4% rise in demand production declining by 3% in 2007.
- Long Term futures market is trending higher.
- Build out of scrubbers by eastern utilities favor Appalachian coal over Powder River basin.
- Industry consolidation.
- EIA forecasting 41% growth of electricity use by 2030, Coals portion will increase from 50 to 57%.
- For nuclear to sustain its 20% market share 35-40 new nuclear plants would need to be built.
- Electric utility demand has only decreased 3 times in the 35 (?)years
- Coal very cost competitive.

Coal powered electric plants to be built in the next few years:
2007-3
2008-5
2009-25
2010-15

<blockquote>