By David Sandell
The Complete Investor
In the 1960s, oil surpassed coal as the world's primary energy source. But coal, for all the environmental and health-related strikes against it, has never gone away entirely - far from it. It has continued to be a major source of electrical power and today accounts for some 40 percent of worldwide electrical consumption. And with oil prices in a long-term uptrend as oil supplies become squeezed, coal is almost certain to gain in importance over the next decade and beyond. As a result, the best-situated coal companies should see their profit grow nicely as the demand for coal rises.
What are coal's advantages? First, its sheer abundance combined with its widespread distribution. While the Middle East contains more than 60 percent of all oil reserves, giving OPEC control over prices and production, coal sells on a far more competitive market, and supply disruptions aren't an issue. And although in the past year prices have risen sharply - by some 80 percent - to more than $60 a ton, coal still is far more economical than other fuels. It costs $3 to generate 1 million BTUs from coal, vs. around $7 for natural gas and $8 for oil.
Coal also is essential in steel production, with 70 percent of the world's steel currently produced in coal-fired furnaces. This use is likely to become ever more important as China and India - expected to account for two-thirds of global demand for coal through 2030 - rapidly build up their infrastructure. China, with 11 percent of worldwide coal reserves, is the world's largest producer and exporter of coal as well as the largest consumer, with coal accounting for more than 70 percent of China's energy consumption. Its use of coal continues to pick up and shows no signs of abating: coal consumption in China grew from 1 billion metric tons in 2000 to 1.7 billion metric tons in 2003. India, with the world's third-largest reserves of coal (after the U.S. and China), relies on coal for at least one-third of its energy. Demand in India is starting to overtake supply, resulting in more imports.
And while coal continues to present environmental drawbacks, some advances have been made, with coal dust controlled through water sprays, compacting and enclosed stockpiles.
In short, coal is embedded in the world's energy markets and is likely to become even more visible in the coming decade. Below are a few companies well positioned to capitalize on coal's growing importance.
Peabody Energy (BTU), traded on the NYSE with a market capitalization of more than $5 billion, is the world's largest coal company. It owns a majority stake in 29 coal operations in the U.S. and Australia and recently acquired a 25.5 percent interest in a Venezuelan mine. Currently Peabody fuels 10 percent of electricity generation in the U.S. and more than 2.5 percent worldwide. A low-sulfur, low-cost producer, marketer, and trader, Peabody should be able to take advantage of the growing global demand for coal and expects to double annual production by 2010. With its strong position as a coal producer coupled with its low PEG of 1.6, Peabody Energy is a buy with a target of 95.
Consol Energy (CNX) is a coal and gas producer and services provider focused primarily on electrical generation within the U.S. According to the company, its coal and gas production accounts for more than two-thirds of total U.S. electrical output. With respect to its natural gas operations, the company simply produces pipeline-quality gas to sell to wholesalers. Its coal operations, however, which account for more than 60 percent of overall revenues, are broader. As owner of the country's second-largest coal reserves and operating the largest number of underground coal mines, Consol Energy is active in mining, processing, and marketing its coal to power generators, steel producers, and other users. The company's services division assists in activities such as disposing of coals wastes and transferring coal from rail cars to ships. Through a subsidiary, Consol also owns timber and farming interests and is involved in commercial development ventures. Paying a small dividend, Consol Energy is attractively valued among coal producers, and we recommend buying with a target of 48.
Headwaters Inc. (HDWR) is a diversified bet not only on coal's future but also on newer alternative fuels that may gain importance in coming years. The company is comprised of three main business segments. Its technology innovation division works to convert coal and heavy oil into environmentally friendly and more effective energy sources. The energy services division focuses on commercializing technology to develop clean coal-based synthetic fuels for use in electric generation. Finally, through its resources division, the company is in the forefront of the burgeoning fly ash market. Fly ash is a coal by-product used to make cement that is stronger, more durable, and easier to work with. Headwaters has captured 50 percent of the U.S. fly ash market through its own development as well as through acquisition, with its products found in Home Depot and Lowe's. With a PEG of just 0.8, Headwaters is considerably undervalued. We recommend buying Headwaters for a target of 40.
Editor's Note: David Sandell is a contributor to The Complete Investor, P.O. Box 248, Williamsport, PA 17703, 1 year, issues, $129.
