Like almost everything else that comes out of the ground, prices for coal have been strong of late, as demand has outstripped supply. This has translated into strong stock prices for many coal mining companies. As the second-largest producer of coal in the United States, Arch Coal
Arch Coal announced that fourth-quarter revenue grew 48% to $553 million. Volumes (including pass-through transactions) rose 37%, and the company saw stronger pricing across most of its operating regions. Operating and net income were also up strongly on the higher sales.
Forward guidance was not as rosy, though. In part because of anticipated problems in the first quarter -- tied to rail shipments and production at the Mingo Logan mine -- the company forecast earnings per share of $1.50-$2.00 for 2005. That's a fairly wide spread, but even the high end of that forecast is below the Wall Street mean of $2.26.
Does this reduction in guidance mean that the boom times are over for coal?
I say no.
Coal companies have been increasing their capital expenditures with an eye toward producing more coal, but that hasn't yet translated into a lot of increased production. While the undersupply of coal might be easing a bit, demand is still outstripping available supply, and stockpiles are well below five-year averages.
On the environmental front, Arch could have an ace up its sleeve. A large percentage of Arch's coal is classified as Powder River Basin coal -- a type of coal with lower energy content, but lower sulfur content as well. While PRB coal normally trades at a considerable discount to Appalachian coal, increased environmental concerns could improve that valuation gap in Arch's favor.
In other words, if sulfur dioxide emission allowances become too expensive for utilities (the major users of coal), that increased cost will compensate for the lower energy content of PRB coal and should drive demand (and prices) higher.
There is no denying that Arch Coal is facing some challenges, and Fools can be forgiven if they are put off by the negative trailing free cash flow and lowered guidance. That said, this could be a diamond in the rough for patient investors who believe in the conversion to PRB coal. Trading at well below its peers, Arch still possesses valuable reserves, good contract exposure, and solid mining capabilities.
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Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.