Coal: It's not just for locomotives and Christmas stockings anymore.
Actually, most of us already knew that. The U.S. power grid is still coal-based. And with natural gas prices soaring and the public at large still cringing from nuclear power, coal is having its time in the sun. As the largest public coal company in the world, Peabody Energy (NYSE:BTU) is making some cool green from those black chunks.
Continuing a trend we've seen for a while now, Peabody's revenue in the third quarter was up 33% as a modest single-digit increase in volume combined with strong pricing. Profitability also improved considerably -- by 94% on a per-ton basis -- and that stoked a doubling of operating profits and a 161% rise in net income. It should also be pointed out that these gains aren't just accounting fairies; operating cash flow rose by more than 100% in the quarter and exceeded net income.
A warm summer, replete with a 26% increase in cooling degree days (a measure of the amount of energy used for cooling), forced utilities to run down their coal stocks even more. Whereas utilities went into the summer with inventories about 20% below normal, they ended this quarter more than 30% below the average. Making matters worse, despite the strong demand and pricing for coal, railroad issues and production bottlenecks kept a lid on supply. Even China is no help, as Peabody management expects Chinese exports of coal to decline by double digits because of increased domestic demand. That's bad, perhaps, for the likes of HuanengPower (NYSE:HNP), but good for domestic coal companies like Peabody, Arch (NYSE:ACI), Massey (NYSE:MEE), and Foundation (NYSE:FCL).
Furthermore, there's nothing set in stone that coal has to be used as coal. There is technology to convert solid coal into liquids or gases, and those can be used in place of diesel and natural gas in many applications. While there is still plenty of room for improvement in the processes, both coal-to-gas and coal-to-liquids are economical at current natural gas and oil prices. That's good news not only for companies like Sasol (NYSE:SSL) and Headwaters (NYSE:HW) that have technology in those markets, but also for coal providers if and when utility demand slows up a bit.
My issues with Peabody Energy stock have almost nothing to do with fundamentals and almost everything to do with the market. Simply put, coal stocks (along with other energy ideas) have become very volatile as day traders and hedge funds freak out to every wiggle and waggle in the energy market. I'm not making a value call here at all; I'm simply stating that I'm not sure I need the day-to-day headaches of watching stocks swing by large amounts for no particular reason.
For more on the coal and mining sectors, see:
Fool contributor Stephen Simpson owns shares of Headwaters.
