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The state of coal stocks is strong
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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 (CNX, news, msgs) has just signed a huge contract to deliver its high-sulfur, high-BTU coal to American Electric Power (AEP, news, msgs) beginning in 2007. Past regulatory action has forced utilities, especially utilities in the Midwest and the Northeast, to add scrubbers to their power plants. Once this emissions-reducing equipment is installed, it becomes cheaper to burn -- and scrub -- higher-sulfur coal from nearby Appalachian coal fields than to buy lower-sulfur coal from more distant mines in Wyoming's Powder River Basin. The guaranteed demand and pricing from the deal gives Consol the security to expand production from its 2.6 billion ton reserves in the Northern Appalachians.
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 (CNX, news, msgs)
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 (AEP, news, msgs) from Consol Energy's nearby fields in northern Appalachia. I think that deal is a sign of others to come as more and more utilities in the Midwest and the Northeast add scrubbers that permit the clean burning of cheaper high-sulfur coal. Consol Energy has reserves of about 2.6 billion tons, and the deal with American Electric Power has led Consol Energy to plan for expanding production. As of Feb. 3, I'm adding these shares to Jubak's Picks with a September 2006 target price of $92 a share.
Buy Headwaters (HW, news, msgs)
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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