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Coal Continues to Creak

By Stephen D. Simpson, Simpson, – Updated Nov 15, 2016 at 6:06PM

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Despite current sentiment, long-term fundamentals still hold up.

Thursday was a bad enough day for coal stocks. Today, at least as of noon, it had gotten even worse. And as is so often the case when entire sectors get hot, particularly cyclical ones, the babies often get chucked out with the bathwater. In other words, it probably wouldn't have made too much difference what kind of quarter Arch Coal (NYSE:ACI) reported -- when the market doesn't like coal stocks, it's not going to love Arch, either.

Like Peabody (NYSE:BTU) the other day, Arch Coal reported a relatively strong second quarter but suggested that third-quarter results would be under pressure. Revenue rose less than 1% for a weak showing, but ongoing operating improvements led to a huge jump in operating income and a doubling of adjusted EBITDA.

Neither volume nor pricing looks especially strong relative to last year, though the numbers don't tell the whole story. Overall tonnage sold dropped 8% from last year's second quarter, but in the interim, the company disposed of some Appalachian coal assets. In what you might call the "core" business, the Powder River Basin (PRB) coal operations, tonnage sold increased 10% from last year, and pricing and margins rose strongly.

The reasons that Arch's stock has fallen on hard times aren't so different from those behind the drops at other energy companies, such as Chesapeake (NYSE:CHK) or Apache (NYSE:APA). Namely, production for coal, oil, and natural gas has been rising, inventories have been refilling, and demand into the summer wasn't quite as strong as forecast.

Not helping matters is that Arch is a little more sensitive to falling prices because it keeps a larger amount of coal out of long-term contracts. For instance, Peabody is about twice as large in terms of quarterly production, but both companies have similar unpriced volume available for 2007. So when prices are weaker, as they are now, folks get nervous about what Arch's future revenue is going to look like.

As I mentioned yesterday, coal's fundamentals are strong -- more and more coal-fired plants go on the books, and the price-per-BTU gap between coal and oil (and natural gas) suggests to me that coal conversion will become increasingly interesting. All that said, Arch is neither the cheapest nor best-run coal company out there, so the primary investment attraction here is if you really want to play a better-than-expected recovery in PRB coal prices.

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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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Stocks Mentioned

Peabody Energy Corporation Stock Quote
Peabody Energy Corporation
BTU
Chesapeake Energy Corporation Stock Quote
Chesapeake Energy Corporation
CHKA.Q
Apache Corporation Stock Quote
Apache Corporation
APA
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