Coal's Run... Over or Not?

Coal's Run May Be Far From Over

By Jamie Dlugosch | 11 July 2008

The bear market pulls down Arch Coal and gives investors an opportunity to take advantage of a short-term[!?!] correction in the stock.

As if someone threw a light switch, the coal sector made an abrupt turn to the downside July 2 when investors decided to cash in on huge gains. In two days of trading in advance of the Fourth of July, shares fell nearly 20% across the board. Such is life in a volatile bear market. Even the sectors that are managing to perform in this environment can get crushed at the drop of a hat.

The price for speculation is certainly increasing, but what about investing? Can investors make a buck in this environment? Our participants in Strategy Lab Open have been making more than a buck or two investing in the entire energy complex, including coal. Does the recent pullback in the group, specifically as it relates to Arch Coal (ACI), provide a buying opportunity for long-term investors?

One of our best investors, Jim Van Meerten, is skeptical and states, "If you are looking at Arch as a long term play I think you may have come to the dance too late, the big money seems to already have been made and all the big players got here way ahead of you."

Blogger Tom Armistead concurs, "Arch Coal (ACI) has been a wonderful growth story, making its way from $27.76 to as high as $77.40 over the past year. It recently sold off to the tune of 15%, closing [today] at $59.89, which raises the question whether this is a good time to try to catch the falling dagger— a question I would answer in the negative."

I would tend to agree with the above, but I think we need to be open to the possibility that coal's run is far from over. Though I agree with those who say oil is a bubble waiting to pop, I am not certain such a deflation is imminent. Even then, I am not convinced falling oil prices would be detrimental to the coal sector. Specifically, coal offers some intriguing advantages over its carbon brother. Clean-burning technology allows coal to be considered an alternative to other, more-polluting sources.

With supplies of coal plentiful in the U.S., demand for Arch's reserves can be counted on to drive future earnings. Absent that, I would be less than enthusiastic. As for the bubble talk, I would contend that an end may be down the road. Check out any other bubble over the past decade and what you will see is a significant lag between the time of its identification and its collapse. That means investors can enjoy a period whereby the risk in speculating is fairly muted. Investors relying on momentum then can increase profits by adding to positions when stock prices drop unexpectedly.

That seems to be the case with Arch. After last week's two-day correction, Citigroup raised its rating of Arch, confirming the buy-on-the-dips thesis. The fundamentals certainly suggest doing so. Russ of RD's Picks pipes up with this: "ACI fundamentals still look strong. Despite a trailing PE of over 40, the stock sells for only 11 times 2009 estimates[!?!] and those analyst estimates have been climbing steadily over the past few months." Many investors have been burned by great fundamentals that suddenly go sour when earnings collapse. That was the case with the home-building sector. Will it be the same with coal?

I don't think so.

As I mentioned above, coal demand is fairly strong. If you include the potential of coal-to-liquid technology, we could see coal usage increase even if demand for oil drops. Add in the power-generation needs of the rest of the world, and you have the ingredients for long-term gains with Arch. I would be a buyer, taking advantage of a short-term 15% correction in the stock, but I'll let blogger Russ have the last word:

"Energy stocks in general have been doing well in this tough market. Although there's no way to know for sure if that will continue, I don't see any reason for energy companies to start underperforming." Given that strength, having some energy exposure in a portfolio makes a lot of sense, and Arch is a good way to get that exposure.

[ Normxxx Here:  Myself, I would wait until the trough of our oncoming recession; probably in 2009, certainly by 2010 (unless this IS the End of the World). Remember, prices of energy stocks don't usually peak until the last stages of a bull market; so, what's the hurry? We're surely past the last bull market and way early for the next.  ]

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.