Contemplating King Coal

 | Jul 02, 2013 | 9:30 AM EDT
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Note: This piece is the second installment of a multi-part series. See part one here.

My drive across the vast open expanse of America's West landed me in Cody, Wyo., last night. As a West Coaster, even I was surprised that we could cover only two states over two days of driving -- Nevada is a long run when going south to north, with not much there other than one of the largest open-pit copper mines in the world, near Ely. A quick cut across northwestern Utah, and a sliver of Idaho brings you into western Wyoming, one of the most beautiful wilderness areas on earth. 

Wyoming sits on the periphery of America's new energy belt, as some of the prolific shales extend into the state. However, Wyoming made its name in energy mainly on its vast coal reserves. Those are still there, but they're declining in value as new emission standards combine with low natural gas prices to reduce demand for the black briquette. Coal is mainly used for power generation, and utilities as varied as Duke Energy (DUK), FirstEnergy (FE) and Dominion (D) have all announced multiple closures of coal-fired generators. 

The stocks of the major coal producers are getting destroyed right now. Peabody Energy (BTU), for instance, has lost 75% in the last five years. While that is shocking, it's benign compared with Arch Coal (ACI), which has dunk 93% in five years -- and Alpha Natural Resources (ANR), also down 93%. A superficial analysis would suggest simply ignoring them and looking for the latest social-media stock. Is it all that simple though? 

Being an "old timer" in the market, I couldn't help but notice a pattern similar to the defense stocks. Nowadays, every thinks highly of General Dynamics (GD), Lockheed Martin (LMT) and the like. But the grey haired portfolio managers will recall that these names had been left for dead in the early 1990s-defense wind-down after the Iron Curtain fell. For instance, GD lost more than 50% of its value after the fall of the Berlin Wall. However, look what happened after that. 

Astute investors -- including one by the name of Warren E. Buffett -- made 6x their money in GD during the next five years of secular decline in defense spending (and way more after that). Lockheed Martin was a triple in the same period. Despite declining defense spending, those management teams recognized their situation and ran the businesses for profitability, not growth. 

While I am not saying today is the day, I am suspicious that we could see the same situation play out in coal. The management teams are not living in fantasy land. Rather, they understand they are in a declining business, and they will start to run their companies accordingly. Coal is so hated and so down-and-out that, at some point, the profitability will return -- at much lower volumes. The defense industry achieved amazing results, and the tobacco industry also does so on a daily basis. 

It is time to put coal on your radar screen, to start doing your homework and to prepare to invest in an industry that can eventually recover just as surely as defense did in the 1990s.

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