Tickers in this Article: ACI, BTU, JRCC, PVR, CNX, CLD, UNP
The only way to consistently make money in commodities is to swim against the current. When times are flush and everyone is talking about how the world has changed, look to sell. When times are awful and commentary suggests that the world is changing (against the commodity in question), think of buying. Although, Arch Coal (NYSE: ACI) has some legitimate operating challenges and the Environmental Protection Agency (EPA) issues could lead to a stagnant domestic market, this looks like the right time to think about buying good coal producers. (For additional reading, check out: How To Invest In Commodities. )

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A Tough Third Quarter
If there was anything good about Arch Coal's third quarter, it was that management had told the Street not to expect much. So, it was a tough quarter, but not all that surprising.

Revenue was up 37% this quarter, with pricing up 13% on average and shipments down 9% - despite the closing of the ICG acquisition. Shipments were hurt by flooding-related problems affecting Powder River Basin (PRB) coal (shipments down 20% in tons from last year), as well as a roof collapse in a West Virginia mine that halted production for about 45 days.

Profits suffered with the lower production levels and higher operating costs. Earnings before interest, taxes, depreciation and amortization rose just 5% and reported operating income was down 6%. On an accounting basis, per-ton operating profit rose almost 10%, while climbing 24% on a cash basis. Both metrics are valid, but gives investors different kinds of information.

A Balanced Approach Can Still Pay
Arch Coal has made an unusual move to reinvest in Appalachian coal assets at a time when many companies like Peabody Energy (NYSE: BTU) are looking elsewhere. To be sure, there are challenges in Appalachian coal mining, and its much more expensive to mine than PRB coal. Still, it's not all bad news.

Arch Coal saw an average per-ton price for its Appalachia coal of $86.50, compared to $13.62 for PRB. Likewise, there is a difference in operating margin - on a per-ton cash basis, Arch earned $18.88 for each ton of Appalachian coal and $2.94 for each ton of PRB coal.

Energy - Here and Over There
One of the positives of PRB coal is that it produces less pollution, though its energy content is lower. Given that the EPA is getting more and more strict about utility emissions, this is not an insignificant issue - and one that could be problematic for a company like James River (Nasdaq: JRCC) or Penn Virginia (NYSE: PVR) which have less PRB coal reserves and more in Appalachia.

Low natural gas prices and rising EPA standards may stagnate U.S. utility coal demand - a concern certainly for Arch Coal, as well as major rail carriers like Union Pacific (NYSE: UNP) and Norfolk Southern (NYSE: NSC), that rely on coal for a large percentage of carload volume. At the same time, though, demand in China and India continues to grow, and Arch may well find that export growth more than compensates for lower U.S. demand (likewise, rails can still profit by carrying that coal to the ports).

The Bottom Line
Low valuations across the sector give would-be coal investors a lot of choices. There's Penn Virginia and its tax-advantaged distributions (and its growing midstream gas business). There's Consol (NYSE: CNX) and its arguably undervalued shale gas assets ((which it will exploit with the help of Hess (NYSE: HES) and Noble Energy (NYSE: NBL)). There's the big dog in the yard, Peabody, which is aggressively expanding overseas, and there's the Powder River pure play Cloud Peak (NYSE: CLD).

Arch Coal has a lot in its favor. The company is prioritizing the higher-value metallurgical coal used in steel, but also moving to maximize its coal-exporting potential. Better still, using an EBITDA/EV multiple at the low end of the historical range, results in an attractive target price (in the $27 - $33 range), assuming the 2012 EBITDA estimates don't need to come down substantially more. (For additional reading, check out: 5 Must-Have Metrics For Value Investors. )

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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