Why Now Is the Time to Buy Coal

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful." 
--
Warren Buffett

It's pretty easy to be down on the coal sector right now. From an environmental and social perspective, each pound of bituminous coal (the type used in electrical generation) emits between 1.7 and 3.2 pounds of carbon dioxide according to data on ThinkGlobalGreen.org.

From a fundamental perspective, coal is encountering a three-pronged problem. First, decade-low natural gas prices are coercing electric utilities to switch to natural gas for electricity generation since it's cheaper than coal. Second, slowing growth in China, the world's largest user of coal, has shareholders worried that import levels could stall or shrink. Finally, the abundance of new technology, including solar, wind, and hydroelectric power, has green industries abuzz with their possible applications.

Let's face it, this is an easy argument to go along with and it's one of the reasons my fellow Fool Travis Hoium came out against coal so harshly last week. But I'm all for preaching Warren's words of wisdom and diving headfirst into a sector when things appear their bleakest. Let me tell you why I feel coal is too enticing of an investment to pass up right now.

The capital costs
While many would love to see natural gas replace coal-fired plants as the primary mode of electrical generation, that just doesn't seem feasible at the moment. Based on research from the Aspen Environmental Group in 2010, it would cost $743 billion to completely upgrade coal-fired plants to be natural gas ready. Let's take a closer look at how the costs of that $743 billion bill would break down.

The new pipeline needed to maintain these plants would cost $348 billion alone and could take years, or even decades, to install. In addition, there are training costs, and natural gas gathering facilities and underground storage units would need to be built. The last time I looked, neither the U.S. government nor many electric utilities were sporting the cash to make this a reality.

The infrastructure isn't there
The truth of the matter is that, at least for now, most alternative energy technologies are just a pipe dream. There's a reason Chrysler will only build roughly 2,000 of its new bi-fuel Ram 2500 HD, capable of running on natural gas and gasoline: a lack of infrastructure. There are, according to CNBC, only 505 CNG fueling stations in the entire United States, and the costs of converting these vehicles to cleaner-burning natural gas creates a sticker shock that could take the owner years to recoup (if ever!).

The same can be said for the solar sector. At the moment, solar subsidies are drying up worldwide and solar panel prices continue to fall. The lesson is simple: If a technology isn't practical, the market will continue to adjust its price down until it becomes practical. For solar panel manufacturer First Solar (Nasdaq: FSLR  ) , which is idling much of its generating capacity and recently reduced revenue estimates again by $200 million, this couldn't be truer.

It's simple push-pull economics
To me, the math behind why coal makes sense seems pretty simple. At some point during the conversion of coal-fueled plants to natural gas, the increased demand would stretch the natural gas supply beyond its limits and cause its price to rise dramatically. Similarly, the weakening demand for coal would cause its price to drop to increasingly attractive levels.

This is exactly the reason why natural gas companies have almost unanimously been proactive in reducing their capital expenditures this year. Chesapeake Energy (NYSE: CHK  ) , responsible for 8% of the nation's natural gas production, recently announced it would curtail the number of dry gas drilling rigs in operation by 50%, with Canada's EnCana also announcing steep cuts in its capital expenditures.

We can't go cold turkey
I'd compare coal consumption to cigarette smoking, but there's just no way we can go cold turkey on the energy resource that's responsible for 45% of all energy generation in the U.S. and 41% worldwide. You may refer to coal companies as evil, but these stocks make a product that is a necessary evil to power our everyday lives.

The international scene plays just as much a part in coal consumption as the United States. Asia, primarily China, is responsible for 5 billion short tons of coal consumption per year, with Europe accounting for an additional 1 billion short tons. The United States consumes 1.1 billion short tons each year.

The valuations are too enticing
Finally, and most important, the valuations on coal companies are as cheap as I can ever recall. Excessive fear-mongering in the sector coupled with the worries listed at the beginning of this article have created what I feel are bargain-basement prices in many coal stocks.

ACI Price / Book Value Chart


ACI Price / Book Value data by YCharts

At just 60% of book value, Arch Coal (NYSE: ACI  ) appears to be the steal of the sector. Its dividend yield of 4.3% dwarfs that of nearly every other coal producer and its price-to-cash-flow value of three is well below its decade-long average. Because of its reliance on coal exports to China, I feel this is the perfect time to take advantage of the overwhelming negativity surrounding the "slowdown" to 7.5% GDP growth in that country and consider buying into Arch Coal.

If you prefer larger operations, Peabody Energy (NYSE: BTU  ) has resisted the trend in the sector to close mines in the face of weakening demand. With an earnings yield of 13.6%, a dividend yield of 1.2%, and a forward P/E even lower than Arch's at 6.4, Peabody is offering investors a chance to own one of the nation's largest coal operations at just a fraction of its decade averages.

Foolish roundup
Coal isn't a perfect solution to the energy sector's problems, but it is a long-term answer to meeting our energy demands. This isn't to say that new technologies won't be made and implemented, because they will -- but the magnitude of these new platforms will be small and their rollout agonizingly slow. The entire coal sector is priced at levels that are far too enticing to pass up, and I encourage you to check into these companies for yourself and see why coal could be the answer to the pressing question on everyone's mind: "What should I buy?"

What do you think: Is coal a long-term solution or on its way out? Tell me and your fellow Fools your thoughts in the comments section below.

Coal and natural gas may be all the rage right now, but our analysts feel there's only one energy stock you'll ever need. Find out for free what stock could power your portfolio higher by clicking here!

Editor's note: A previous version of this article stated that General Motors builds the Ram 2500. The Fool regrets the error.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He's been told he has a black heart, but that doesn't mean you can mine it! You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

Motley Fool newsletter services have recommended buying shares of General Motors, First Solar, and Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's powered by hugs.


Read/Post Comments (26) | Recommend This Article (56)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 10, 2012, at 2:23 PM, DAG1996MF wrote:

    Nice to see an occasional article here that isn't advising investors to fall into the hype trap to buy high and sell low. Perhaps the world won't stop using all forms of coal tomorrow after all.

  • Report this Comment On April 10, 2012, at 2:46 PM, CluckChicken wrote:

    "There's a reason that General Motors (NYSE: GM ) will only build roughly 2,000 of its new bi-fuel Ram 2500 HD, capable of running on natural gas and gasoline: a lack of infrastructure."

    Not a truck person are you? My guess is that GM will build zero Ram 2500 HD since they make Silverados and the Rams are Dodge.

    There is just way too much going against coal to suggest that any of these buys would be long term. Best I think one could hope for is that they end up with the winner of the consolidation of the market.

    I do not think that the big worry with China is that they are slowing it is that they are current constructing 25 nukes to replace coal plants. India is building numerous nukes to replace coal plants. Even tough in the next 5 years several new coal plants will come on-line in the US the total output of coal plants will shrink because of the number going off-line.

    Coal will slowly die and be needed in steel production, unless some new tech is found, but there is little to suggest that tomorrow will a better then today for coal.

  • Report this Comment On April 10, 2012, at 3:27 PM, hbofbyu wrote:

    Cluck,

    "...there is little to suggest that tomorrow will be better then today for coal."

    How about cost?

    Back in the 70's the line of thinking was there is only so much oil in the ground, they told us oil will be gone by the year 2000. Gasoline powered cars were too dirty, air pollution was at its peak. Coal is too dirty for our air. Acid rain in the 80's would be the demise of coal. Nuclear power would replace coal.

    Damn. And it still hasn't happened yet.

    Go figure. Coal will be around until you find something cheaper to replace it. Right now that is not nuclear, not solar, not wind and not natural gas.

  • Report this Comment On April 10, 2012, at 4:06 PM, CluckChicken wrote:

    Well there are 10 coal power plants being built and 250 natural gas plants. Throw in a very high chance of there being tighter polution regs on power plants and mining practices. All of this is bad for coal.

    But you think price will keep it strong. Coal has been the cheapest energy source since the 70s yet has seen a decline each year since 2007. In 2009 there was a 10% decrease in usage. Over the next 5 years the DOE is already projecting a decrease in coal usage and they have not received requests to build more plants beyond those scheduled for completion in 2017, so little to sugggest more will be used by then. Add in that gas is now at it's most competitive price to produce vs coal since the early 70s and is projected to be for the forseable future, price is not a stronge enough factor for coal.

    I am not saying coal will disappear any time soon but there does not appear to be anything to say there will be an increase in demand.

  • Report this Comment On April 10, 2012, at 4:10 PM, Kaintuck30 wrote:

    I have a fair amount of experience working within both coal and natural gas industries. Given my time in these sectors, I think Sean may have drawn conclusions from industry-wide booking values that don't really tell the full story about what's happening.

    I do agree with him on a couple of points. First of all, "green technology" isn't going to save the day anytime soon. I'm happy to see efficiency improving in the solar field, but I really don't think solar will play a substantial role in our energy consumption for decades. And barring some magic that hasn't been unvieled yet, wind and biofuels are a joke. In my opinion, these industries are nothing more than government subsidized feel-good exercises that waste financial resources.

    What I think he misses, though, is that personal consumption isn't going to drive the increase in natural gas consumption any more than it does coal consumption. Yes, in the end it comes down to electricity use, but the big decisions are made by the utility company, not by John Doe down the street. Thus, the truck comparison is unfounded.

    What does matter is that it is much cheaper to produce gas than coal (especially given the new shale plays), cheaper to transport, and much cheaper to convert to electricity. A natural gas fired power plant can be constructed for the cost of the scrubbers on a coal fired plant (literally, check the numbers for yourself), and scrubbers have a life of 30-40 years, at which point they have to be replaced. Finally, nat-gas power plants require substantially less human labor and maintenance to produce a given amount of electricity.

    Sean does make a good point that coal isn't going to go away tomorrow. That's true. I would note that horses didn't go away after the automobile was invented either, they were just marginalized. My money's on gas.

  • Report this Comment On April 10, 2012, at 8:53 PM, GETRICHSLOW2 wrote:

    Arch is an incredible buy at todays price and market conditions. I would avoid Peabody. I bought both stocks seven years ago with the hope that something would become of the coal-to-liquids movement.

    I have not made a penny on either of them. Although Arch is down considerably since I bought, it's current balance sheet is solid and the 4% div is nice. Peabody needs to do something with it's pathetic 1.2% div to provide some shareholder value before I would be a buyer.

  • Report this Comment On April 10, 2012, at 9:49 PM, ElCid16 wrote:

    Arch Coal's Debt/Equity ratio is about 2.0. You might want to consider using some EV valuation metrics in your analysis.

    And just to clarify, their P/FCF is definitely not 3. (Maybe their P/OCF, but that doesn't seem very useful.)

  • Report this Comment On April 10, 2012, at 10:22 PM, ElCid16 wrote:

    Just one more point, then I'll stop.

    Considering these are coal companies, you'd think BV would be ok to use, because goodwill wouldn't be substantial. But this isn't the case.

    ACI's goodwill spiked almost 400% in the last year, alone. BTU's also spiked in 2011. Maybe a tangible book value metric would be more useful.

    I'm not trying to completely poke holes in your analysis, but these guys aren't that cheap. I have a few coal losers sitting on my CAPS page, but don't really have any strong desire to add any in real life.

  • Report this Comment On April 11, 2012, at 5:30 PM, pbass003 wrote:

    How do you reconcile the article you ran titled;

    "It's Time to Abandon Coal Stocks"

    By Travis Hoium | More Articles

    April 5, 2012 | Comments (22)

    with this article? The reason I subscribe to The Fool in the first place is because I am too dumb to figure this stuff out for myself. This is not helping.

  • Report this Comment On April 11, 2012, at 5:39 PM, TOM48 wrote:

    What about Patriot Coal(PCX)? It is at a 4 year low & is the only independent coal producer that mines coal for use in making steel. Could it be time to pull the trigger on this one?

  • Report this Comment On April 11, 2012, at 6:41 PM, EDJMCPS wrote:

    The reason there are conflicting articles is because the writers have conflicting ideas. They are usually different writers. I have run into this in the past myself. They are great for ideas and some direction but in the end it is always up to you to make the final decisions. Motley Fool turned me on to ARMH years ago when it was at the $5.00 to $6.00 range. I rode them for years building a very good position. Then they said sell nothing was happening. There are times were you have to go your own way and I hung on to them selling 1/2 in the 30's. Other times I have sold on there say so and glad I did. In the end it's you call, there great advisors for ideas but you have to make the call.

    On coal I like the idea; will I invest? I don't think so, to many other places to go.

  • Report this Comment On April 11, 2012, at 7:31 PM, cozmick wrote:

    @Sean Coments, including "it would cost $743 billion to completely upgrade coal-fired plants to be natural gas ready" & "increased demand would stretch the natural gas supply beyond its limits" are misleading at best. Few are seriously discussing the conversion of coal plants to gas fired... the cost (as you suggest) is unreasonable when you could simply tear those plants down and build new gas fired plants in their place. With natgas production, reserves, capacity at an all-time high it is foolish to suggest that increased demand for natural gas will outpace supply for the foreseeable future. Natural gas infrastructure is in-place to meet additional demands related to any possible increase related to additional investment in gas-fired generation, and there are several MLP’s out there that will be fighting for the opportunity to build-out the infrastructure that isn’t in place. Finally, emissions from coal-fired generation are in the cross hairs of the POTUS and the EPA. Emissions regulations have led to the announced closure of dozens of GW of coal plants over the last year alone and if POTUS has his way CO2 tax will be the next leg down for coal. Your analysis and examples are deeply flawed and your recommendation is equally flawed.

  • Report this Comment On April 11, 2012, at 8:01 PM, adamnb1 wrote:

    You could split the difference between coal and gas with Penn Virginia Resource Partners, LP (PVR: $22+, that is both a coal royalty trust and a natural gas processing MLP (sporting a current yield of 9%.)

  • Report this Comment On April 11, 2012, at 8:51 PM, lowmaple wrote:

    The fact China is building nuclear doesn't necessarily mean they won't be using coal as they will need lots of energy to provide to the growing middle class. Their huge dam's energy was used up fast enough.

  • Report this Comment On April 12, 2012, at 5:43 AM, stefaith wrote:

    One point which no-one wants to mention is that the hypothesis that CO2 cases global warming is still just that, a hypothesis. You wont see it mentioned in the NY Times or the Observer, but global temperatures have plateaued for the past 12 years in spite of a 16% increase in CO2.

    When a scientist advances a hypothesis to explain certain observed phenomena, he then should test his hypothesis by experiment if possible; else he predicts certain consequences. All the predictions of the AGW crowd have not come to pass. This does not necessarily prove them wrong, but it does suggest that there are holes in their theories which need to be covered.

    It is quite possible that soon someone will completely explode the connection between global warming and CO2, just as so many other theories that have acheived popular approval have been exploded in the past.

    A good example of this was the 2K scare concerning the massive failure of computers at the turn of the century. It didn't happen, and all knowledgable computer people knew it would never happen, but they were all making so much money out of it that they kept mum.

    Another was the DDT scare triggered by the book, "the silent spring". As a result DDT was banned, and millions of Africans died of malaria. DDT is now used once again in Africa to kill mosquitoes and keep malaria in check.

    Political correctness may be used as a substitute for intelligent analysis, but it's not science and never will be.

  • Report this Comment On April 12, 2012, at 8:19 AM, jiggs3 wrote:

    It would seem that with the price of coal as low as it is, considerably lower than natural gas, and the demand for energy increasing at exponential rates around the world, there should be technology focused on coal emissions - at least imrpoving the environmental damage done by coal. It is hard to imagine that this viable energy source goes away anytime soon.

  • Report this Comment On April 12, 2012, at 10:00 AM, Waltermouse wrote:

    So, "each pound of bituminous coal . . . emits between 1.7 and 3.2 pounds of carbon dioxide?" Wow. Burning ONE pound of coal makes the planet THREE pounds heavier? Didn't know we could do that.

  • Report this Comment On April 12, 2012, at 12:00 PM, pcruicks wrote:

    Have a read of this article. Clean burning of Coal! They are heavily involved with Chines companies that manufacture steel and generate electricity.

    http://www.cnsx.ca/Storage/1442/132016_NR-12-05_MCI_commerti...

  • Report this Comment On April 12, 2012, at 12:03 PM, pcruicks wrote:

    http://microcoal.com/

    Low emission coal burning IS here.

  • Report this Comment On April 12, 2012, at 12:46 PM, pcruicks wrote:
  • Report this Comment On April 12, 2012, at 3:51 PM, oldman144 wrote:

    There is nothing in this article that I disagree with. Coal truly is king and maybe someday we can come up with something better.. Actually there is and it's called nuclear power-- but the fear of nukes keep it in the evil darkness.

    So in trying to stay in the real world I have loaded up with BTU and now it's time to wait for reality to rear it's smoky self.

  • Report this Comment On April 12, 2012, at 7:03 PM, maniladad wrote:

    Waltermouse: When burned Carbon (coal) + O2 (oxygen) makes CO2 (carbon dioxide). The extra weight of the emissions is from the oxygen. It's not created de novo. But if you're still worried about the earth getting too heavy, go out and plant some trees, which take the extra weight and convert it back to carbon (as wood) and put the oxygen back into the atmosphere.

  • Report this Comment On April 13, 2012, at 1:49 PM, Praguegypsy wrote:

    Rothschild is buying coal companies, that's a fact. Who is big behind the CO2 scare? NWO/Rothschild. Could it be that he is using the environmental bimbos to help him to drive coal companies' stocks down so he can buy on cheap? I don't have the research power available to Buffet or Rothschild, so maybe just following their footsteps may be the second best practice. I'll bet that after he has assembled his coal empire, the CO2 will disappear from the mass media (if they are still around).

  • Report this Comment On April 14, 2012, at 1:13 PM, Darwood11 wrote:

    We will continue to use significant amounts of fossil fuels. That means coal, oil and natural gas.

    The proportions may change and there will be other sources. Let's not forget nuclear. As with other areas of my investments, I'll continue with a diversified portfolio.

    If someone could figure out how to tap the caldera under Yellowstone, we'd have another source of cheap electricity. No one has yet figured that out. Geothermal may one day be a significant possibility in the U.S.

    However, political meddling i.e. funding specific companies, is doing not much more than flushing money and generating a lot of buzz. My point here is such meddling is not, in my opinion, lowering my day to day living costs. It seems to be raising my taxes. But certain people like to ignore taxes when discussing "cost of living."

    Considering where energy is expended in the U.S. economy, home energy improvements and transportation should be at the top of the lists. Smaller homes or higher density? OMG! What sacrilege!

    On the other hand, recent demands for improved automobile fuel economy will be a game changer. In 1969 I had a small car which was considered "hot." The 4 cylinder engine was rated 103 SAE HP as I recall! It did not have air conditioning and many of the amenities people today demand. One "luxury" was an FM radio. I don't quite recall the fuel economy, but with a 1.9L high compression engine it needed hi test gas. Check out today's so called "economy" cars and many of them have larger engines than that one did, and lower MPG figures! Why? They do weigh more with crash improvements, but they also have air conditioners and lots of electronics which does use electricity derived from power provided by the internal combustion engine. Those "economy" cars are also rated for acceleration and that has always been a big deal for Americans. So modern small cars actually have more horsepower and use more fuel MPG than my "hot" 1969 auto.

    Many are also faster 0-60MPH.

    The bottom line? It would be very easy to get most small cars to 40MPG, but Americans would have to accept the performance hit. Manufacturer's are not stupid and they won't build something that people will not purchase and this is a very competitive area. BTW, perhaps the readers haven't noticed, but hybrid sales are not keeping pace. Why? Perhaps it's the "true cost to own?" According to Edmunds.com, it costs $542 more each year to own a Toyota Prius Two than a Honda Fit; that's for the first 5 years.

  • Report this Comment On April 17, 2012, at 3:28 PM, setht23 wrote:

    I'm all over ARLP at these prices. It has a higher book value than most stocks in this story but very low debt, and has an almost 7% dividend.

  • Report this Comment On May 09, 2012, at 1:44 PM, njn81 wrote:

    Coal is black gold, Japan is considering to phase out nukes and take in coal

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