Sam Stovall's Sector Watch

By Sam Stovall

For Energy Investment, Coal Is King

After stagnating in the '80s and '90s, coal is back and moving fast. S&P believes prices will continue to rise despite mining regulations

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From Standard & Poor's Equity Research

Just about a year ago, the Coal & Consumable-Fuels subindustry index was added to the S&P Composite 1500. And now that the subindex has accumulated the 52 weeks of history required for our relative strength ranking measure, it has become the most recent member of the Industry Momentum List.

And it has been quite a year for these stocks. Since oil and gas prices have risen so dramatically in the past few years, S&P believes coal has become the lower-cost fuel of choice, particularly for utilities. As a result, this subindustry index has risen 125% in the past 52 weeks, vs. a 15% advance for the S&P Composite 1500 Index.

Will this industry leadership continue? Yes, according to John Hingher, CFA, S&P's Diversified Materials analyst. His investment outlook for the coal and consumable-fuels subindustry is positive. After stagnating for much of the 1980s and 1990s, primarily due, in Hingher's opinion, to overcapacity and improved productivity, coal prices began to rise appreciably in 2003, and continued to increase in 2004 and 2005. Rising prices reflect considerable industry consolidation since 1990, combined with increasing demand, driven by an expanding global economy, in S&P's view.

FUEL OF CHOICE.  According to the Energy Information Administration (EIA), coal prices should continue to rise in 2006, primarily in response to growing demand from the electric power sector. Coal remains by far the dominant fuel used for electricity generation, accounting for over 40% of worldwide electricity generation and over 50% of U.S. generation. In 2004, fully 92% of all coal consumed was used for electricity generation.

Hingher notes that utility customers' coal stockpiles are approximately 10% to 15% below five-year averages, as demand recently outstripped supply. He believes coal will likely remain the fuel of choice for some time, as oil and natural gas prices remain high and nuclear and hydroelectric power generation is capacity constrained.

The analyst's longer-term outlook is also positive, as the EIA forecasts a 1.9% compounded annual growth rate in total U.S. coal consumption between 2004 and 2030, primarily due to a projected 1.5% compound annual rise in coal use for electricity generation.

TOP PICKS.  However, Hingher also believes the coal industry faces several obstacles, including near-term transportation difficulties as U.S. railroads operate near capacity; the potential for increasing environmental regulation on coal production and utility emissions; increasing low-cost supplies from what he sees as relatively undeveloped international mines; and difficult geological and mine permitting conditions in the eastern U.S.

So there you have it. From both a fundamental and momentum standpoint, S&P believes the investment outlook for the S&P Coal & Consumable Fuels subindustry index continues to look favorable. S&P's top picks in the group include CONSOL Energy (CNX) and Massey Energy (MEE), both of which are ranked 4 STARS (buy).

Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of April 28, 2006.

Subindustry
Agricultural Products
Coal & Consumable Fuels
Construction & Engineering
Construction Materials
Diversified Metals & Mining
Human Resource & Employment Services
Multi-Sector Holdings
Oil & Gas Drilling
Oil & Gas Equipment & Services
Oil & Gas Refining & Marketing
Railroads
Steel
Trading Companies & Distributors

Stovall is chief investment strategist for Standard & Poor's Equity Research Services

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