All Systems Go at Arch Coal

Remove the keystone from an arch, and that arch will crumble.

When profitability was chiseled out of Arch Coal's (NYSE: ACI  ) operations by the commodities crash of 2008 (and into 2009), investors fled for shelter from the falling debris.

Despite remaining the second-largest domestic coal producer behind my top coal pick Peabody Energy (NYSE: BTU  ) , Arch Coal's shares have consistently lagged the performance of competitors since the financial crisis first collided with a booming coal industry. Not until that disastrous mine explosion in April that sent shares of Massey Energy (NYSE: MEE  ) diving did Arch Coal even find some company at the bottom of the coal pack.

As last week's impressive quarterly report from Arch Coal makes clear, however, the keystone has been replaced, and the company has been substantially restored. Just last quarter, I refrained from recommending an investment in Arch Coal, given the array of competitors that appeared more attractive.

Upon close inspection of this latest result, however, and with the longstanding weakness in the stock price, I conclude that Arch Coal could make a winning combination for Fools eager to ride a laggard's rush to rejoin the pack.

Arch Coal rode a 38% increase in revenue to a convincing adjusted profit of $0.43 per share in the second quarter. Thanks to an increased proportion of coveted Central Appalachian coal in its product mix, the miner's cash operating margin improved by 39% over the first quarter (to $2.69 per ton from $1.94).

Every indicator that a coal investor must track is moving in the right direction. Coal demand is rising both domestically and globally. Utilities' domestic consumption during the first half of 2010 increased by 25 million tons over the first half of 2009. Meanwhile, total domestic coal production decreased by 15.5 million tons over the same period.

Thanks in large measure to the met coal component of those Central Appalachian coals, Arch Coal realized a 6% increase in sales prices compared with the first quarter, and reiterated guidance for 6 million to 7 million tons of met coal production in 2010. CONSOL Energy (NYSE: CNX  ) , for its part, loaded a record 43 vessels filled with export coals at its wholly owned port facility in Baltimore during the second quarter (for 3.3 million tons). Offering further corroboration, Norfolk Southern (NYSE: NSC  ) observed a dramatic 177% increase in coal export volumes shipped over its rails during the second quarter.

Reflecting this persistent strength, Arch Coal raised its guidance for increased U.S. export volumes in 2010 to as much as 20 million tons over 2009 volumes. Management even stated that recently acquired assets in the Illinois Basin could "expand our customer reach, both domestically and internationally." If severely landlocked coal supply from the Illinois Basin becomes economical as an export supply, then the bullish structural shifts underway in the global coal market will have reached another major milestone.

As Arch Coal's shares begin to come back to life, I sense a Foolish opportunity. I would like to see more cash on the books to counterbalance a debt load of $1.5 billion, but operationally this company is back on its feet, with a promising bit of upside as this long-term bull market for coal gathers steam once again.

The coal tag in the Motley Fool CAPS community lists 30 coal companies. Find out what other investors are saying about the stocks you're watching, or share your Foolish thoughts with us. CAPS is free and fun!

Fool contributor Christopher Barker hopes that the global atmosphere won't one day resemble a volcanic ash cloud. He can be found blogging actively and acting Foolishly in the CAPS community under the user name TMFSinchiruna. He tweets. He owns shares of Arch Coal, CONSOL Energy, and Peabody Energy. The Motley Fool scrubs its disclosure policy before releasing it into the atmosphere.


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