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Coal Stays Green

By Stephen D. Simpson, Simpson, – Updated Nov 16, 2016 at 2:16PM

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Arch Coal continues to benefit from strong demand and constrained supply in the coal market.

While the steel market may have started to cool and oil prices seem like they're settling into a range, coal continues to be a hot commodity. Despite per-ton pricing that is about as good as it's been in over five years, coal production has remained flat, and stockpiles are low on a historical basis.

For the country's second-largest coal miner, Arch Coal (NYSE:ACI), all of this seems to spell ongoing profits.

Despite expected troubles at the company's Mingo Logan mine in central Appalachia, revenue climbed 49% in the first quarter to just over $600 million. Total volume sold increased over 43% to 37 million tons, and the average per-ton operating margin increased 13%.

As a result, Arch Coal saw operating income (excluding gains/losses) grow almost 53% to just under $36 million. While the company also produced considerably more operating cash flow, shareholders shouldn't expect to see a lot of that in their own pockets. The company remains free cash flow negative, because of high ongoing capital expenditures.

For the first quarter, Arch Coal saw particular strength in its Powder River Basin coal operations. Volume sold increased over 42%, and the per-ton operating margin increased 17%.

For a variety of reasons, this could be just the beginning of a strong run in PRB coal. Rail service to the region improved markedly during the quarter, and pricing has strengthened as more utilities decide to include greater amounts of PRB coal in their fuel mix.

Remember, while Arch Coal's PRB coal has significantly less energy content than Appalachian coal, it also has significantly fewer pollutants (like sulfur dioxide) per ton. In fact, roughly three-quarters of the company's coal reserves meets the stringent Clean Air Act requirements without any specialized equipment like scrubbers.

Given that the price for sulfur dioxide emission allowances climbed 20% in the quarter to roughly $850 per ton (compared with $130 ton in January 2003), utilities clearly have a growing incentive to switch to less-polluting coal.

Valuing coal companies like Arch Coal is tricky. What's more, it's not especially rewarding in the short term, since coal companies seem to be trading more off the spot price of coal than future discounted cash flows. Nevertheless, with a reserve life of around 26 years and a huge stake in low-sulfur coal, Arch Coal would seem to deserve consideration alongside PeabodyEnergy (NYSE:BTU) as "best in breed" coal miners.

Given that it will take at least a year or two for capital expenditures across the industry to translate into increased production, pricing for the company looks pretty secure. What's more, with demand for new indications like coal gasification and liquefaction on the rise, the outlook for coal seems to be pretty rosy for at least the next few years.

For more Foolish thoughts on producers of these hunks of ex-dinosaur:

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

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