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Jubak's Journal Recent articles: • 5 stocks for the next spending surge, 2/1/2006 • The new risk from China: deflation, 1/31/2006 • The housing bubble is deflating -- but gently, 1/27/2006 More... | Jubak's Journal The state of coal stocks is strong After the State of the Union address, we know this: It's going to be business as usual in energy policy. That removes a big part of the risk in coal stocks. By Jim Jubak That was a "business-as-usual" State of the Union address President Bush delivered on Tuesday. No big initiatives. Little new money, even for priority programs. Hey, you don't set the ship of state on a new course by re-upholstering the chairs in the passenger's lounge. If you're worried about the state of the union, this lack of action may leave you quivering in fury. And, conversely, if you like the direction we're going in, it's likely to leave you quite satisfied. But no matter where on that spectrum your emotional reaction to this business-as-usual speech falls, the lack of new initiatives means the federal government isn't going to rock the boat in the energy sector. And that sends a very clear message to investors. Buy coal stocks. (Yes, I'm saying it again.) Even after the huge run-up they've had. They are the clear winners in the U.S. energy sector for the next five years or longer.
Coal, which went into the speech as the leading "alternative" to oil and natural gas, comes out of the State of the Union as the big winner because the president didn't propose anything to change the current market momentum. Similarly, other alternatives, from solar to wind to nuclear to hydrogen, are big losers from business as usual.
Playing the percentages If you listened to the State of the Union address with even half an ear, you couldn't miss President Bush's call to action on energy. "America is addicted to oil, which is often imported from unstable parts of the world," the president declared. "So tonight I announce the Advanced Energy Initiative, a 22% increase in clean-energy research at the Department of Energy to push for breakthroughs in two vital areas. To change how we power our homes and offices, we will invest more in zero-emission coal-fired plants, revolutionary solar and wind technologies, and clean, safe nuclear energy. We must also change how we power our automobiles. We will increase our research in better batteries for hybrid and electric cars, and in pollution-free cars that run on hydrogen. We will also fund additional research in cutting-edge methods of producing ethanol, not just from corn but from wood chips and stalks or switch grass. Our goal is to make this new kind of ethanol practical and competitive within six years. Breakthroughs on this and other new technologies will help us reach another great goal, to replace more than 75% of our oil imports from the Middle East by 2025." Related news and commentary on MSN Money
The first rule in listening to any speech is this: Beware a politician bearing percentages. So it's critical to ask what that 22% increase in money really means. The 22% increase in spending for the Advanced Energy Initiative in the budget for the fiscal year that begins in October 2006 breaks down this way:
To put that $685 million in context, last summer's energy bill provided $2 billion in tax breaks for oil and gas drillers over the next five years. And the solar-energy plan recently approved by the California Public Utilities Commission provides $3 billion in subsidies over 11 years to businesses and individuals for installing solar-energy systems. That, California officials estimate, would be enough to power 2.2 million homes and eliminate the need for six modern fossil-fuel burning power plants. The second rule in listening to a Washington speech is, of course: Watch the long-term forecasts. The president's goal is to reduce oil imports from the Middle East by 75% by 2025. I wouldn't hold my breath waiting for the payoff from the Advanced Energy Initiative, if I were you. If the president's plan is too little to change the momentum of U.S. energy production and consumption anytime soon, that would leave current trends intact. And those trends favor coal. I laid out the trend toward coal in my Jan. 24 column, "6 ways to invest in the coming coal boom." To summarize, the U.S. Department of Energy's Energy Information Administration projects that coal consumption in the United States will climb by 73%, to 1.9 billion short tons in 2030 from 1.1 billion short tons in 2004. Picking up steam The trend toward coal is still in its early stages, too -- the period when trends tend to accelerate before settling into a second stage of maturity, when growth hits a steady rate and way before any decline. Utilities are just starting to shift their orders for new power plants to coal-fired turbines and away from natural-gas turbines. Turbine makers project that coal-powered units will make up about 40% of all orders for electricity turbines in the next 10 years. In 2000, coal's share was 25% to 30%. And now, after the State of the Union, investors know that while the state of California may be budgeting to replace six fossil-fuel fired power plants with solar panels, the U.S. government isn't about to follow suit. Absent intervention from Washington, the trend toward coal, already strong, will build on its own momentum. Just look at Headwaters Investors might also want to note that this $1.5 billion market-capitalization coal-technology company is profitable enough to spend $12 million on research and development and still generate earnings of $2.79 a share for the fiscal year that ended in September 2005 on $1.1 billion in sales. Business as usual in this year's State of the Union address has left the energy market free to set its own priorities. For example, Headwaters is doing a booming business in turning fly ash from coal-fired power plants into concrete because the process provides a cheap way to dispose of tough-to-handle waste -- and because using fly ash to replace commonly used Portland cement results in substantial reductions in carbon-dioxide emissions. That's happening while the State of the Union address is only talking about developing technologies sometime in the future to reduce carbon-dioxide emissions from coal-fired plants. The trends put in place by past government action will continue to play out. Coal producer Consol Energy Reinventing the ethanol wheel The State of the Union address could have announced initiatives that might have put this trend toward coal in danger -- not in danger of ending in 2006, perhaps, but of slowing or ending prematurely. And that possibility would have worried investors. Coal stocks have already had a good run. Consol Energy is up 400% in the last three years. Headwaters has climbed 141%. An investor doesn't want to buy these shares unless the trend is set to run long and fast from here. I can imagine a federal program that would turn solar into a real competitor in the electricity market -- maybe even enough of a competitor to damp demand for coal and hold down the price. Such a program would realize that subsidies to install solar equipment aren't the solution anymore, because its a shortage of silicon solar cells and other equipment that is now holding the market back. A federal program that targeted not more research and development with a payoff in 2025, but more manufacturing now might have raised that risk for coal investors. Or how about an ethanol program for plant waste (instead of corn) that, again, wasn't targeted at research and development but at importing proven Brazilian technology and cheap Brazilian ethanol made from sugar cane waste? No need to reinvent the wheel -- the Brazilian technology works, and adding demand from the huge U.S. energy market would drive the technology even faster toward improvement. But that ethanol technology wasn't invented here, and so we'll work to create our own and look for results by 2025. Do you see why business as usual removes a big part of the risk in coal stocks? It also sets the stage for future profits from coal stocks even after the rally they've had. So much so that I'm going to add two more coal stocks to Jubak's Picks with this column. Updates Buy Consol Energy All coal stocks aren't equal, and right now I like Consol's exposure to the high-sulfur U.S. energy coal market. Both thermal (energy) coal for export across the Pacific and metallurgical coal segments of the market are seeing price pressure. But U.S. demand for coal for generating electricity continues to surge. What has moved Consol Energy to the top of the buy list among coal stocks is the big deal -- commencing in 2007 -- to supply high-sulfur coal to American Electric Power Buy Headwaters Think of this as a technology a stock. Yes, you're buying shares in a company with real revenue, $1.1 billion in the fiscal year that ended in September 2005, and real earnings, $2.79 a share. But the true growth prospects for the company come not from its established business turning coal waste, such as fly ash, into concrete and construction materials, but from its technology-innovation group. That business has just finished testing a technology that promises to improve yields of lighter fuels from heavy oils by 20%, and it is looking to sign its first commercial contract. Other technologies in the group are used to turn coal into liquid fuels and in cleaning coal (and recovering coal from coal waste). These technologies will, I believe, start to contribute significantly to growth in the next few years, and if successfully commercialized should drive multiples on the stock well above today's price-to-earnings ratio of 11 times trailing 12-month earnings per share. As of Feb. 3, I'm adding these shares to Jubak's Picks with a target price of $47 a share by July 2006. New developments on past columns "5 reasons the Fed will fumble in 2006": Worries about inflation in the United States might be keeping new Federal Reserve chairman Ben Bernanke up at night, but I'm cheering at signs of inflation in Japan. After years and years of falling prices kept the Japanese economy trapped in a deflationary slump, a pickup in inflation is good news. In December, the core consumer price index rose 0.1%. Not much, but the second straight month of price increases and the first time in seven years -- seven years -- that the economy had strung together two straight months of price increases. The Bank of Japan has said that consistent inflation is a prerequisite for the bank to raise short-term rates above 0%. Such a return to something resembling normalcy could come as early as April, although I think the central bank will be more cautious and wait until later in 2006, thanks to pressure from Japanese politicians who don't want to see any interest-rate increase choke off the recovery. Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six-month recommendations. For suggestions to help navigate the treacherous interest-rate environment, see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective, see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||||||
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