Buy, Sell, or Hold: Arch Coal

When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upsides outweigh its risks. Let's take a look at Arch Coal (NYSE: ACI  ) today, and see why you might want to buy, sell, or hold it.

Founded in 1969 and based in St. Louis, Arch Coal sports a market capitalization near $1.5 billion. It's involved in producing and selling steam coal and metallurgical coal from U.S.-based mines. Steam coal is mainly used by power plants and industry, and metallurgical coal is used in the production of steel. As of the end of 2011, its proven and probable recoverable reserves of coal totaled 5.33 billion tons.

Whacked by a slowdown in China's economy coupled with low prices for natural gas, the stock has tumbled about 55% over the past year.

Buy
A key reason to buy into a company such as Arch Coal has long been the relative stability of its business. Utilities have always needed coal to produce power, and manufacturers have demanded steel, which requires coal. But times have changed a bit. With natural gas now so inexpensive, and concerns about pollution from coal heightened, many power plants are converting to running on gas. Still, demand for steel remains, and though it's cyclical, a period of rising demand seems to be around the corner as world economies launch infrastructure projects and manufacturing picks up as consumers are more able to spend.

Better still is news from China that it will be spending some $280 billion on infrastructure, which sent shares of Arch Coal up more than 20% in a single week, and boosted many of its peers, as well.

Arch has recently signed several deals to export coal to Asia and elsewhere, and expects to quadruple its export volume over the coming decade.

If you seek dividend income in your investments, Arch Coal delivers, though with just a 1.6% yield. The relatively low yield reflects a 73% dividend cut that happened earlier this year. A further cut is not out of the question, but the big cut does have an upside, allowing the company to conserve cash.

Another plus for Arch Coal in the eyes of some investors is speculation that it might be acquired by a rival, such as Peabody Energy (NYSE: BTU  ) or Walter Energy (NYSE: WLT  ) . Such buyouts do tend to happen at a premium to the going price, delivering a boost to shareholders, but remember that speculation is far from a done deal.

Sell
On the negative side, Arch Coal has recently turned free-cash-flow negative, largely due to sizable capital investments, and its net income has recently turned to net losses, as well. On top of that, debt is another concern, having swelled from about $1.1 billion in 2007 to $4.9 billion recently, while the company's cash coffers hold only about half a billion dollars.

Meanwhile, while China remains the world's largest coal consumer, it's important to note that the country has also been spending heavily on developing alternative energies. So its demand for coal may well drop in coming years.

One more worry is that further environmental regulations might be imposed on the industry, putting more pressure on coal companies' profitability. Violations of environmental rules can also be costly -- an Arch subsidiary appears to be on the hook for about $575 million in fines.

Finally, the overall picture for coal remains worrisome, as soft demand could keep coal companies rationing their production and failing to maximize profits.

Hold (off)
Given the reasons to buy or sell Arch Coal, it's not unreasonable to decide to just hold off. You might want to wait for the price of coal or the price of natural gas to rise. You might wait for Arch Coal to post a string of profitable quarters, as well.

You might also look at other coal-related companies, or companies mining other natural resources, such as Cliffs Natural Resources (NYSE: CLF  ) , which specializes in iron ore and metallurgical coal and has recently moved to shed some of its coal assets. If you're expecting a big boom in manufacturing, you might also look directly at steel makers, such as ArcelorMittal (NYSE: MT  ) . It offers geographic diversification and vertical integration, and solid growth prospects in China. Still, some analysts have downgraded the stock.

The verdict
I'm not investing in Arch Coal, at least for now. It may perform spectacularly in the coming years, but there are plenty of other compelling stocks out there. Everyone's investment calculations are different, so, do your own digging and see what you think.

If you like energy stocks, we've got another stock you should look at more closely. Read about it right here in The Motley Fool's special free report on the energy industry and its best prospects. It's free, but only available for a limited time, so click here today.

Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, holds no position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of ArcelorMittal. Motley Fool newsletter services have recommended buying shares of Walter Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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