Peabody Energy Corporation (BTU), Arch Coal Inc (ACI) & Norfolk Southern Corp. (NSC): Profiting From Rising Coal Demand

With the abundant supply and cheaply priced natural gas in the U.S, the clean fuel has successfully replaced coal in many industries. While coal prices have declined by nearly 25% over the last year, the rising domestic gas demand and increasing liquefied natural gas (LNG) exports have pushed up gas prices by nearly 30%. As a result, electric utilities now prefer coal over natural gas due to its low price. In fact, for the first four months of 2013, coal’s contribution to the total power generation rose by 410 bps year-over-year, while the natural gas share slipped by 370 bps year-over-year. So the question arises, how do you profit from this trend?

Coal manufacturers

Since coal demand is on the rise, it would be obvious to think that top coal manufacturers stand to benefit here. But that isn’t the case.

Peabody Energy Corporation (NYSE:BTU) is the world’s largest private-sector coal company with around 9.3 billion tons of proven reserves. The coal behemoth generated almost around 54% of its FY 2012 revenue from the U.S, while its Australian mines accounted for the rest.

To boost its revenue, Peabody Energy Corporation (NYSE:BTU) recently ramped up its Australian coal production (by 30%) to record levels. This might give the advantage of economies of scale, but will most likely lead to higher foreign exchange losses. With the slowing Australian economy and recovering U.S economy, analysts at Fidelity estimate that the Australian dollar will go in free fall. In my opinion, the coal industry is already challenging, and mounting forex losses could nullify Peabody Energy Corporation (NYSE:BTU)’s earnings growth, in case there’s a free fall.

On the other hand, Arch Coal Inc (NYSE:ACI) is the second-largest coal producer in the U.S with around 5.5 billion tons of proven coal reserves. But the company operates with a debt/equity ratio of 184%, which is one of the worst in the entire industry. Its long-term debt aggregates to $5.1 billion, while its quarterly interest expenses amount to $95 million.

The company posted a loss of $755 million in FY 2012, which is further expected to worsen since coal prices have depreciated by nearly 25% year-over-year. Its cash and cash equivalents stand at just $730 million, which are not enough to bear another loss-making year. This leads me to believe that Arch Coal Inc (NYSE:ACI) will tend to leverage further, just to stay afloat. Thus, I wouldn’t recommend Arch Coal Inc (NYSE:ACI).