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

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How to proceed

Since the idea is to profit from higher domestic coal demand, and not rebounding coal prices, I believe that investing in the railroads sector would be a great idea. For this reason, Norfolk Southern Corp. (NYSE:NSC) pops up as one of the prime beneficiaries.

Norfolk Southern Corp. (NYSE:NSC) is one of the largest railroad operators in the U.S., owning or holding interests in over 20,000 route miles of the railroad network. The company operates on a fee-based structure, which means that its profitability depends on higher coal volumes rather than its market pricing.

The best thing about it is that Norfolk Southern Corp. (NYSE:NSC) generates around 25% of its revenue from the transportation of coal, which is mainly provided to electric utilities. Although the company generates 20% of its revenue from intermodal transportation, it is still 400 bps to 500 bps more leveraged toward coal, as compared to its peers

Since it is these electric utilities that are driving up coal demand, Norfolk Southern Corp. (NYSE:NSC) doesn’t have to look for potential clients to bolster its growth. Additionally, it already has an established and well-connected network to service these electric utilities, which suggests that its growth will come almost immediately at a minimal expense.

On the fundamental’s side, its shares appear to be undervalued with a forward P/E of 11.7x. The company enjoys better-than-average net margins of 16.1%, which have been the key to its sustainable growth. And due to the expansion of its intermodal network amidst recovering industry-wide prospects, BMO Capital Markets recently upgraded Norfolk’s shares to outperform with a price target of $91 per share (23% premium).

Final words

With that said, I think Norfolk Southern Corp. (NYSE:NSC) is a great company with solid growth prospects. But it’s worth noting that coal is in greater demand because of its low price. If its price increases dramatically, it would leave little reason to prefer coal over natural gas. Thus, the investment thesis of this article holds true for oversold coal prices.

Piyush Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

The article Profiting From Rising Coal Demand originally appeared on Fool.com.

Piyush is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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