Coal Stocks Getting Hotter Amid Disruptions

BOSTON (TheStreet) -- Coal never seems to lose its luster.

Shares of U.S. producers of high-grade coal used in steelmaking are rising on expectations they will get much higher prices on a jump in demand as flooding in Australia has shut mines and roiled the international market.

Even before the events in Australia, institutional investors had been buying big stakes in U.S. metallurgical coal producers. BlackRock ( BLK), one of the world's largest institutional investors, bought an 18% stake in Massey Energy ( MEE) in the period ending Dec. 31, while Fidelity raised its holding to 13% of its shares at the end of the third quarter, it's most recent reporting period, according to Morningstar data.

Massey's shares are up 3% this year, which brings its market value to $5.7 billion. The stock tripled in 2009 and rose 28% last year.

Individual investors are now being advised to take a look at the sector.

Last week, Deutsche Bank ( DB) initiated coverage of several companies with metallurgical mines. It gave Patriot Coal ( PCX) and Walter Energy ( WLT) "buy" ratings, and Massey Energy a "hold" rating.

"We favor North American coal companies with exposure to the metallurgical coal market that are reasonably valued," Deutsche Bank analysts said in a note to clients. "Logistical constraints and supply disruptions are catalysts that can drive volatility and support higher prices."

Patriot's shares are up 27% this year, but analysts are mostly negative on its shares, giving it one "buy" rating, eight "holds" and three "sell" ratings, according to FactSet.

That hasn't deterred institutional investors. ArcLight Capital is Patriot's largest shareholder with a 12% stake, according to a Dec. 22 filing from the firm.

Walter Energy's shares are up 1% this year. Fidelity bought 1.2 million of its shares in the third quarter, upping its stake to 3%, which is about half that of Harris Associates, the largest shareholder.

Penn Virginia ( PVA), a U.S. oil and natural gas producer, is also seeing buying from big institutional investors, despite its market value of only $815 million.

BlackRock initiated a 16% stake in Penn Virginia in the reporting period ending Dec. 31, while in the third quarter, Seneca Capital initiated a 4% stake, and Artisan Partners, a 2.4% stake. Luxor Capital has a 10% stake, the second largest of big investors, followed by Wellington Management at 7%.

But TheStreet Ratings analysts have a "sell" rating on Penn Virginia, citing its abysmal share-performance record, which includes three successive years of decline: 40% in 2008, 17% in 2009 and 20% last year.

But it may have turned a corner as its shares are up 7% this year.

Alpha Natural Resources' ( ANR) shares are down 2% this year. It is a diversified North American coal producer, thanks to the recent acquisition of Foundation Coal. That deal has given it exposure to Appalachia's metallurgical coal market.

Consol Energy ( CNX), with a market value of $12 billion, is up 6% this year. Institutional buyers have been feeding on its shares, as Wellington Management, the largest shareholder, bought more shares and upped its stake in the third quarter to 12%, while BlackRock initiated an 11% stake late in 2010, according to a Dec. 31 filing.

Consol garners 12 "buy" ratings, three "outperform," three "holds," one "underperform" and two "sell" ratings, according to FactSet.

Investor interest in metallurgical coal producers is straight out of Economics 101: supply and demand.

Production in Australia, the supplier of half the world's metallurgical coal and the primary source for Asian steelmakers, could take months to recover as open-pit mines have to be pumped out and rail lines that deliver coal to ports will need to be restored.

Government and banking sources in Australia said that the disruption could cut the world's supply of metallurgical coal by 5% this year, according to a Reuters report.

Given the shortages, and the prospect that supply won't meet demand, metallurgical coal prices are skyrocketing. Eventually that will also impact the price of steel.

Last Wednesday, Commonwealth Bank of Australia estimated metallurgical coal prices would rise 30% to $293 a ton.

Last Friday, the international energy and metals consulting firm Wood Mackenize said it expects prices will surge to $400 to $500 a ton because of supply shortages. "Most supply regions have been producing at capacity and replacement tonnage will be difficult to secure."

But many producers are locked into long-term supply contracts and won't be able to take full advantage of the jump in spot-market prices.

The previous market peak for metallurgical coal was $350 to $375 a ton in 2008.

Adding to market woes, U.S. production in Appalachia has been disrupted by severe weather, which is expected to temporarily impact supply and drive prices higher in the U.S, even as export demand rises.

The Appalachian Region is the world's second-largest source of metallurgical coal, but producers there have also been bedeviled by the weather. Alpha Natural Resources warned Friday that weather-related issues have interrupted production, delayed rail service and slowed exports at its ports. As a result, it expects its cost of sales on the East Coast will rise by about 6% per ton.

International demand for metallurgical coal had already been on the rise over the past year, particularly from emerging markets such as China, India and Brazil, and also Japan.

As a result, the outlook for coal producers was shaping up favorably, even before the supply issues. Morningstar analyst Michael Tian said in a Jan. 10 research note that "2011 might look even better than 2010, should metallurgical coal prices remain sky high."

That's because, "contrary to earlier expectations, China's economy continued to roar along (in 2010)," he said. "Steel production in particular has increased about 15%, ahead of GDP growth."

Shares of Peabody Energy ( BTU), one of the worlds' largest coal producers, are are down 3% this year. Most of its production is of thermal coal, which is sold to energy producers for use in power plants.


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