Coal: Clearer Picture

David M. Khani, CFA
FBR Capital Markets
703-469-1179
[email protected]

Heading into 2010, we continue to be optimistic on the coal space in general and believe that most companies under our coverage should have improved operational and financial performance supported by improving macro trends and increased global trade.

The key tenets of our coal investment thesis in 2010 are: (a) strong metallurgical coal demand; (b) robust export outlook; (c) continued resurgence of steam demand due to colder-than-normal winter; and (d) regulations will maintain an overhang on supply and potentially on demand, which is modestly slowing after a strong pace earlier. We are still cautious on the broader market, looking for a pullback and then the opportunity to be more aggressive on the smaller names.

We remain buyers of the larger companies (Peabody Energy, Consol Energy, Alpha Natural Resources, Arch Coal and Massey Energy) and would prefer to buy on a pullback given the recent run in 4Q09 and the first few weeks in January.

We believe the group has 20% upside after we increased our price targets by about 19%, but we expect that if strong weather continues and inventory declines further strengthen, our steam coal price could prove conservative.

Natural Resources Partners L.P. reported strong 4Q09 earnings per unit of $0.39, higher than the FBR estimates of $0.31 and consensus of $0.26, primarily driven by higher revenues (particularly non-coal royalty) and larger share of metallurgical production.

The stock currently trades with a yield of 8.7% and offers coal investors an alternative way to invest in the coal space through a yield-based investment.

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Shneur Z. Gershuni, CFA
UBS
212-713-3974
[email protected]

Year-end 2009 coal stockpiles at U.S. electric utilities closed at 189.8mm tons, breaking back below 200mm tons with an impressive 6.7% drop. These levels translate into 74 days of coal burn based on trailing 12-month demand, relative to the five-year average December inventory days of 47.