Coal Stokes Wall Street Furnaces

The surge in oil prices has fueled a frantic search for alternative energy investments.
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High energy prices are powering more than oil and gas stocks.

They are fueling a rally in "alternative" energy companies -- most notably coal producers -- and some related firms as well.

In today's pricing environment, coal companies can charge twice as much for their product as they did just two years ago. Eager customers, particularly domestic power producers and Chinese steelmakers, are lining up to buy high-priced coal that is nevertheless still affordable when compared to oil and natural gas. Coal producers are, in turn, relying more heavily on railroad companies to ship out their supplies. And even ambitious alternative energy companies, seeking to replace traditional fuel sources, have become attractive to some.

So while many people simply gape at high energy prices -- and scream about the giant companies that profit from them -- some investors are simply looking the other way. They are hunting for stocks, beyond the

ExxonMobils

(XOM) - Get Report

of the world, that tend to look pretty when energy prices do not.

Bob Howard, author of the investment newsletter

Positive Patterns

, has been bullish on energy -- particularly the supermajors -- for some time. But he sees upside in coal and railroad stocks as well.

Howard especially likes

Penn Virginia

(PVR)

, a coal royalty trust, because of its "superior" reserves and solid dividend. Meanwhile, he says, the railroads -- which count coal producers as their largest customers -- are on a nice roll. He says that

Burlington Northern Santa Fe

(BNI)

is "hiring like crazy" to keep up with shipping demands. And he likes

Canadian Pacific

(CP) - Get Report

even better because it caters to the "natural resources bread basket of the world" up north.

"Railroads should be a good place to be for the next few years," Howard said.

But Howard, who has no position in the companies he follows, draws the line at alternative energy stocks. "To me," he said, "that's just pie in the sky."

Old King Coal

Coal is another story. While viewed as an attractive alternative to more expensive fuels, coal has never really left the mainstream.

"Coal is the fuel of choice for 50% to 55% of the electric generation in this country," said Jon Cartwright, director of institutional research at BOSC. "That is, by no means, insignificant."

Moreover, companies are actually starting to build or expand more coal fire-powered plants when faced with running costly gas-fueled plants instead. But those companies could soon find themselves competing with international steel mills for available coal.

Credit Suisse First Boston analyst David Gagliano predicted a possible bidding war for coal as early as next year.

"In this scenario," he concluded, "the North American coal producers are poised to benefit via significant pricing improvements in their long-term coal contracts."

Late last month, Gagliano raised the price targets on every coal stock in his universe due to favorable trends in the industry. And he singled out

Massey Energy

(MEE)

for an upgrade from neutral to outperform as well.

Gagliano favors Massey because of its generous production of the "metallurgical" coal used by steel producers in booming China. But a competing analyst, Paul Forward of Legg Mason, likes

Arch Coal

(ACI) - Get Report

for the opposite reason. Arch produces very little metallurgical coal and caters to domestic customers instead.

As a result, Forward believes, those who worry about a slowdown in China's sizzling economy might be better off owning Arch instead.

"We view Arch as an investment in domestic utility steam coal production that is largely insulated from China uncertainty," explained Forward, when upgrading Arch from hold to buy this month. "While our long-term preference as investors is for coal producers that are positioned to benefit from Asia's growth, we believe that the combination of China fears and very low coal stockpiles at domestic utilities may shift investors' preferences in the near term for coal producers serving domestic steam coal markets."

Cartwright believes the big coal producers will remain solid companies for many years to come. That said, however, he wouldn't necessarily invest in them right now.

"My general take is that we all should have bought them two years ago," he said. "I'm old-fashioned. I like to buy low and sell high."

Railroad Crossing

Then one analyst recommends a major railroad.

Even Gagliano, who doesn't cover the sector, pointed out that railroads have more coal shipments than they can handle. And Standard & Poor's transportation analyst Andrew West confirmed that business is indeed picking up.

Still, one railroad is faring better than the rest. West said that his top pick, Burlington Northern, posted a 7% increase in carloads -- more than twice the industry average -- during the latest quarter. He says the railroad serves a Western region known for its inexpensive coal. And he expects the company's services to become even more attractive as East Coast coal users start looking for cheaper supplies.

"They are bringing lower-cost coal to a geographic region that expects an ongoing increase in volume for the next several years," said West, who has a four-star buy rating on Burlington Northern's shares. "The idea of BNI is a good one."

West has a three-star rating on the other major railroads:

CSX

(CSX) - Get Report

,

Union Pacific

(UNP) - Get Report

and

Norfolk Southern

(NSC) - Get Report

. He says the last is actually benefiting more from price increases right now than it is from higher volumes. In the latest quarter, he says, Norfolk Southern managed to grow coal revenues at four times the clip that it grew coal shipments.

"They had some disputes with customers about how much they were raising their rates," West said. "But that appears to be working out in their favor."

West has yet to see other railroads renegotiate their long-term pricing contracts. In the meantime, he says, they can only grow their revenue through volume so much.

"For the most part," he said, "this is the sort of business that's operated at full capacity, anyway."

Wildcatters

Other investors are actually considering companies that don't have much business at all.

These stock market wildcatters are looking to strike it rich in alternative energy names. But David Schoenwald, manager of the New Alternatives fund, is still waiting for a spark to really ignite the sector.

He says that last summer's blackout heated the stocks up for a while. But he is looking for more lasting events -- like a national energy policy -- to keep the excitement burning.

"Some of these companies don't have a product to sell," he reminded. "There needs to be time and money to do the research, which hasn't been forthcoming -- because of mixed messages and an unclear energy policy -- for a long time."

In the meantime, he says, investors choose his fund because they favor environmentally friendly companies. He calls them "sophisticated" buyers who often thoroughly research -- and even visit -- the companies in his fund. But he also says that most people have a hard time telling the good alternative energy companies from the bad.

Many of the companies earn no money, he explained. And it can be hard to distinguish between real technology and hype.

Walter Nasdeo, an analyst at Ardour Capital, recognizes that some alternative energy companies are better than others. He recommends several --

American Superconductor

(AMSC) - Get Report

,

FuelCell Energy

(FCEL) - Get Report

and

Plug Power

(PLUG) - Get Report

-- that he believes can achieve commercial success. But he steers investors clear of others.

He recently upgraded American Superconductor from accumulate to buy after the company posted solid improvements in the last fiscal year. He also raised his price target on Plug Power, another fuel cell company, as well.

But Nasdeo is less enthusiastic about some other players. For example, he recently downgraded

American Power Conversion

(APCC)

due in part to the company's soaring expenses. He also recommends selling

Hydrogenics

(HYGS) - Get Report

because, he believes, the company lacks focus.

"I like to see companies that have a high focus on a niche market," he said. "And Hydrogenics doesn't have that plan, in my mind."

He says he doesn't recommend any stock lightly.

"I turn over the rocks and see what comes out," Nasdeo said. "It's completely objective. ... I'm really tough on these guys."

But Howard, for one, remains skeptical. When all is said and done, he still favors the ExxonMobils of the world.

Still, Howard admits that some of his own clients shy away from the big oil giant that profits handsomely during times like this.

"If CBS triples its profits, that's great," he said. "If Exxon does, that's evil. ... So getting some people to buy Exxon is like asking them to hang a picture of Richard Nixon up in their home. They're not going to do it."