Another Reason to Like Coal Now

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Although coal use increased in the first quarter at utilities, coal sales fell because energy companies dipped into their stockpiles to meet their fuel needs. Stockpiles are now below their five year average, according to the U.S. Energy Information Administration (EIA). Although 2013 is a transition year, this dynamic should set up rising demand for companies like Peabody Energy (NYSE: BTU), Arch Coal (NYSE: ACI), and Alliance Resource Partners (NASDAQ: ARLP).

Unloved but Still Needed

Coal is an unloved natural resource. However, it still powers around 40% of this country's electric plants. It is abundant and relatively inexpensive. The drop in coal demand has been driven by a fall in natural gas prices, a trend that has started to reverse. Coal use was up 11% year over year in the first quarter according to the EIA.

That jump in demand, however, was filled by tapping into utility stockpiles, not buying more coal. So the coal miners are still suffering. That said, utilities can only go down this route for just so long before they need to start buying more coal to burn and to replenish their diminishing stockpiles. While that tipping point hasn't been reached just yet, investors looking for a catalyst in an out of favor industry should watch this trend carefully.

Those intrepid enough to buy in today should consider:

Still Performing Well

Alliance Resource Partners has increased production in each of the last four years despite the weak coal market. It plans on another production increase in 2013. Revenues, meanwhile, have been similarly strong, as production increases have offset lower coal prices. So, despite the industry's problems, Alliance is putting up record results and expects to continue to do so.

Part of the company's strength comes from its low-cost mines, which it believes can compete with natural gas priced as low as $3. And Alliance is expanding its operations in its core Northern Appalachia and Illinois Basin mines, which should only make it that much stronger of a company.

Alliance is easily one of the best positioned coal miners today. Income investors looking for a coal play should look no further than Alliance and its around 6.1% yield and long history of distribution increases.

Big, With Issues

Arch Coal is one of the largest coal miners in the United States. It had been solidly profitable until 2012 when a non-cash impairment charge led to a steep loss. That charge, however, was “due to the decline in benchmark metallurgical coal prices versus 2011.” In other words, it had to write down the value of its inventory.

The company still lost money for the year even after removing the one-time charge, but it has plenty of financial liquidity. And, the company is looking to export more coal to high-demand countries like China and India.

The tough coal market led to a large dividend cut. However, that provides potential upside for income seekers since the dividend is likely to ratchet higher assuming performance improves. The shares currently yield around 2.9% and trade well below book value. This year will probably be a tough one, but if demand and prices pick up, Arch shares should respond quickly.

Going Global

Unlike Alliance and Arch, Peabody is a large U.S. producer and has material assets overseas. Notably, it has operations in Australia that provide easy access to Asia. That's an important level of diversification since Asian markets aren't as down on coal as a fuel as is the United States. That said, slowing economic growth in the region has placed a drag on demand there, too.

The company remained profitable until 2012, when, like Arch, profits fell dramatically due to one-time costs, including non-cash asset impairment charges. Unlike Arch, however, Peabody would have earned over $2.60 a share without the charges. So, despite the difficult year, the company didn't cut its dividend. It lost about a dime a share in the first quarter.

As coal markets around the world improve, Peabody is well positioned to take advantage of the recovery. Although the 2% dividend yield isn't large, that it hasn't been cut it is a clear sign of strength. The shares are trading a little under book value, so they aren't as good a deal as Arch. That said, Peabody is better positioned for a recovery.

Hate on Coal

The market pretty much hates coal today. That's understandable, but is probably overdone. Investors looking for an industry leader that's still performing well should consider Alliance. Arch has taken some big hits from the tough coal market, but offers notable turnaround potential. Peabody, meanwhile, is a globally diversified option that is struggling, but holding its own.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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