Arch Coal Attracts Soros as Peabody Lures Citadel

By Arijit Ghosh and Christopher Martin

Nov. 24 (Bloomberg) — Billionaire investor George Soros, Citadel Investment Group LLC and T. Rowe Price Group Inc. are snapping up coal mining shares, taking advantage of the cheapest valuations in five years as demand for electricity rises.

Soros bought 2.9 million Arch Coal Inc. (ACI) shares last quarter for a 2 percent stake in the second-largest U.S. coal producer, filings with the Securities and Exchange Commission show. Citadel, the Chicago-based hedge fund, and Invesco Ltd. in Atlanta bought 3.5 million shares of Peabody Energy Corp. (BTU), the biggest miner. T. Rowe reported purchasing stock in Peabody, Arch, Consol Energy Inc. (CNX) and Indonesia’s PT Bumi Resources.

While coal, the cheapest fuel for power, is up 88 percent in Pennsylvania, shares of the companies that mine the mineral have slumped along with the rest of the commodities industry. Now, investors are betting that Peabody, which traded at 3.7 times projected 2009 earnings as of Nov. 21, and Arch at 2.5 times are cheap because coal use will increase. The valuations were at more than a 54 percent discount to the MSCI World/Energy Index.

“Coal is the best commodity to get into right now,” said Daniel Rice, manager of BlackRock Advisors Inc.’s $1.5 billion Global Resources Fund in Boston, which is among the largest holders of Peabody and Arch. “It’s a lot less sensitive to downturns because it’s needed for basic power generation, and demand is growing.”

Crude oil in New York has dropped 43 percent this year compared with a 6.1 percent decline in Australian coal prices.

Consol surged $4.08, or 20 percent, to $24.88 in New York Stock Exchange composite trading. Peabody climbed $2.82, or 15 percent, to $21.57 and Arch Coal rose $1.40, or 11 percent, to $13.70.

Electricity Demand

Demand for electricity in major economies, where coal is used to generate 52 percent of power, will increase 3.3 percent by 2010, according to a UBS AG report on Nov. 17. Global coal use will rise 2 percent a year through 2030, led by China and India, the Paris-based International Energy Agency said Nov. 6.

Coal company shares tumbled this year as the U.S., Europe and Japan entered their first simultaneous recession since World War II. As of Nov. 21, Peabody dropped 79 percent after reaching a record in June and Arch lost 84 percent. Consol, the third- largest U.S. coal producer, slipped 82 percent. Bumi fared the worst among the world’s biggest producers, plunging 92 percent in Jakarta.

The MSCI World Index has declined 49 percent this year, while its energy sub index fell 44 percent. The Bloomberg U.S. Coal Index slumped 75 percent and the measure of coal stocks in Asia dropped 73 percent.

‘Particularly Irrational’

Analysts say the decline has been overdone. While oil company profits will fall this year after New York crude futures dropped, coal producers have the advantage because mining companies have long-term sales contracts that cushion them from falling prices.

“People are dumping all equities and it’s particularly irrational for coal,” said Richard Price, an investment banker at Westminster Securities in St. Louis, who advises coal producers and utilities in the U.S. and China. “Even if contract prices come off next year, they’ve still got the ones signed this year at higher prices.”

Michael Vachon, a New York-based spokesman for Soros, declined to comment. Heather McDonald, a Baltimore-based spokesman at T. Rowe, also declined to comment. Aysha Mawani, spokeswoman at Invesco and Katie Spring at Citadel didn’t respond to e-mails seeking comment.

Bumi Gain

Bumi may advance fivefold, according to the average forecast of 20 analysts compiled by Bloomberg. Peabody will probably more than triple to $58 in the next 12 months, the analysts surveyed by Bloomberg said. Arch has an average target price of $37.69 among 13 analysts, more than three times its Nov. 21 close, the data show.

“I wouldn’t say we’re recession-proof, but certainly recession resistant,” Steven Leer, chief executive officer of Arch, said in a Nov. 19 interview. “People will still be turning on their lights. Electricity demand rarely goes down.”

Profits at Peabody and Arch, both based in St. Louis, will rise next year as less lucrative contracts get replaced with ones signed at this year’s higher prices, analysts forecast. Lower costs for diesel, steel and explosives will help reduce mining expenses, Leer, 56, said.

More Demand

Increased demand from utilities and analyst forecasts for 22 percent profit growth at Bumi attracted U.S. buyout firm TPG and San Miguel Corp., the Philippines’ biggest food and drinks company, to vie for a stake in the company, Asia’s biggest thermal coal exporter. PT Bakrie & Brothers, which agreed to sell its 35 percent stake to North Star Equity Partners, expects TPG’s Indonesian affiliate to decide on the purchase by Nov. 28.

Change in ownership will attract investors because Bumi’s stock is undervalued, said Bryan Collings, who manages $250 million at Hexam Capital’s Global Emerging Markets Fund in London. Bumi is the only Southeast Asian stock he owns.

“If you are looking to buy the stock, it’s a wonderful environment,” said Collings. “Energy hasn’t gone out of fashion and it’s still the core business for Bumi.”

Coal and nuclear plants are the cheapest to operate and more difficult to start up or shut down than natural gas generators. That’s why coal is used to produce half of U.S. electricity and 78 percent of China’s.

India’s government expects imports to double to 40 million tons by 2012 as Asia’s third-largest economy increases coal-based generation capacity by 72 percent. Japanese utilities plan to add 11 percent more coal-fired capacity by 2010, and Indonesia 40 percent by 2011.

Coal Power

China intends to increase coal power by 2010, while the U.S. Energy Department forecasts the world’s biggest economy will boost use of the fuel 24 percent by 2030.

Still, a deepening global economic downturn may drive coal shares lower and curb energy demand.

The 32 percent gain in the Reuters/Jefferies CRB Index to an unprecedented 473.97 on July 3, was followed by a 51 percent decline in the measure. The gauge is set for its worst annual performance on record.

Spot coal prices at Australia’s Newcastle port, an Asian benchmark, dropped 56 percent from a record $192.5 a ton in the week ended July 4. Prices at South Africa’s Richards Bay declined 18 percent this year to $78.15 a ton.

South African prices may average $70 a ton in the next three months and return above $90 within 18 months, Manqoba Madinane, a Johannesburg-based analyst with Standard Bank Group Ltd., said in a Nov. 18 interview.

Falling Prices

Coal prices “will continue to fall” as economic activity deteriorates “very rapidly,” Francisco Blanch, a London-based Merrill Lynch & Co. analyst, said in a Nov. 14 report.

“While there is uncertainty in today’s economy, any easing of demand growth is likely to be offset by diminished coal supply,” Peabody President Richard Navarre said on an Oct. 16 earnings conference call. “Tight supply will be further compounded by the global credit freeze because a significant amount of planned production expansions and new mines will be at risk around the world.”

Arch plans to cut output next year at some of its higher- cost mines in the western U.S. In the east, producers Consol and Massey Energy Co. say they’ve been curtailed by increased mine safety inspections and more difficult reserves to tap.

Indonesian Production

Production in Indonesia, the world’s biggest exporter of power-station coal, will slow as the global credit crisis hampers expansion plans, Fitch Ratings said in Nov. 21 report without giving figures. The Indonesian Coal Mining Association on Aug. 21 forecast a 15 percent increase in output to 270 million metric tons in 2009.

Bumi will remain profitable even at lower coal prices because its production costs are among the lowest in the world, said Peter Ball, a director at the Jakarta-based company.

Bumi expects to sell coal at an average $77 a ton this year and at least at that level in 2009, he said. It cost Bumi $33.10 to produce a ton of coal in the first half, according to regulatory filings. That compares with $75 to $80 a ton in Russia, where coal costs are the highest in the world, according to Ball.

“It’s clear that we’ll keep on making a lot of money no matter what,” Ball said.