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Warren Buffett is Betting Big on Coal

By Jim Fink on January 6, 2011

The bullish case for coal isn’t based on trends in the U.S., though America will play a huge future role as a supplier. Asian demand is the key.

Elliott Gue, The Energy Strategist

On November 7th, a fleet of nine private jets touched down in the sleepy town of Gillette, Wyoming. Population: 30,000. Two of the world’s wealthiest men were among the arrivals. They stayed only one day, and refused to give any interviews. They were here for a very specific reason and saw something that one of them called “fascinating.”

Who were these men and why were they in Wyoming, the least populous state in the nation? 

As the title of this article reveals, one of the men was Warren Buffett, CEO of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B). The other was his bridge-playing buddy, Berkshire director, and fellow billionaire Bill Gates, chairman of Microsoft (NasdaqGS: MSFT). The purpose of their surreptitious trip was to visit the Black Thunder Mine, owned by Arch Coal (NYSE: ACI). Black Thunder is the single largest coal mine in the U.S. with an annual output equaling 10% of total U.S. coal production. 

Why Warren Buffett Finds Both Beer and Coal Fascinating

Sometime after returning from his visit to Wyoming, Buffett was quoted as saying that he found the trip to the Black Thunder Mine “fascinating.” There is only one other time that I can recall Buffett using the word “fascinating” to describe an industry and that was in 2005 when he was describing the beer business.  As you may recall, Berkshire Hathaway purchased 35 million shares of beer giant Anheuser-Busch in April 2005. He sold out three years later for a $770 million profit when Anheuser-Busch was acquired by Belgium-based InBev (NYSE: BUD)

Interestingly, in the same interview where he called the beer business “fascinating,” he called it “fairly easy to understand.” Only a deep value investor like Buffett would equate “easy to understand” with “fascinating.” For Buffett, “fascinating” means a profitable opportunity. Buffett is fascinated by profit, not cutting-edge technology, and what he finds to be most interesting are simple businesses that ride on the coattails of strong economic trends to make oodles of money.

Warren Buffett Already Owns Two Links of the Coal Industry

Buffett apparently views coal today as a profit-making opportunity similar in significance to that of beer five years ago.  Don’t forget that 25% of all the freight carried by railroad Burlington Northern, which Buffett’s Berkshire acquired for $44 billion in 2009, is coal. In fact, Burlington Northern is the nation’s largest hauler of coal, transporting 300 billion tons of coal last year, enough to generate more than 10% of the nation’s total electricity needs. Most of this coal that Burlington Northern ships comes from the Powder River Basin in Wyoming where the Black Thunder Mine is located. And also don’t forget that Berkshire owns MidAmerican Energy, an electric utility that operates 11 coal-fired power plants, four of them located in Wyoming.

A Coal Company is Warren Buffett’s Missing Link

So, Buffett is already into coal big-time through the transportation and electrical generation segments. The only segment missing is the mining segment. Adding coal mining to Berkshire’s investment repertoire would create a vertically-integrated coal powerhouse. Could Buffett be interested in acquiring a coal company?  Buffett isn’t talking, but his actions speak louder than his silence.

When he acquired Burlington Northern, he said it was an “all-in wager on the economic future of the United States.” Similarly, this past September, Buffett told the Montana Economic Development Summit:

I am a huge bull on this country. We will not have a double-dip recession at all. I see our businesses coming back almost across the board.

If you’re bullish on America, you’ve got to be bullish on coal. Coal is an important component of the U.S. economy, powering 50% of the nation’s electricity. Although Australia is currently the world’s largest coal exporter, the U.S. has the world’s largest coal reserves and will surpass Australian in exports in the future. Who will be importing U.S. coal? China and India, whose economies depend on coal for 80% and 70% of their energy needs, respectively.

Coal mines in the Powder River Basin are closest to the Western U.S. ports used to export to Asia, so companies operating there are going to be the prime beneficiaries of the Asian demand for coal. Consequently, if Buffett buys a coal company, it’s likely to be one focused on the Powder River Basin.

Coal Expert Walter Scott is Advising Warren Buffett

The only energy names in Berkshire’s investment portfolio currently are integrated oil companies ExxonMobil (NYSE: XOM) and ConocoPhillips (NYSE: COP). He’s publicly stated that buying ConocoPhillips during the height of the oil price spike in 2008 was a “major mistake” and he has substantially pruned back his position in the oil giant over the past couple years. If you’re worried that energy is outside of Buffett’s “circle of competence” and he might make a similar mistake with coal . . . don’t worry. 

Buffett gets expert advice from Berkshire board member Walter Scott, who is chairman of Level 3 Communications (NasdaqGS: LVLT), a 50-50 joint venture partner with Cloud Peak Energy (NYSE: CLD) in the Decker coal mine, which is located in the Montana section of the Powder River Basin. The Decker mine is managed by privately-held Kiewit Corp., whose headquarters is in Buffett’s hometown of Omaha, Nebraska. From 1979 until 1998 Kiewit’s CEO was . . . you guessed it, Walter Scott. Scott was also CEO of MidAmerican Energy during the early 1990s, so it’s fair to say that Scott understands coal.

With coal expert Scott as Buffett’s confidante, you can bet that Buffett will make an intelligence purchase in the coal space.

Coal Companies in the Powder River Basin are Warren Buffett’s Prime Targets

Below are the publicly-traded coal companies that operate in the Powder River Basin:

Company

Price to Earnings Ratio

Return on Equity

Debt to Equity

Market Cap

Alpha Natural Resources (NYSE: ANR)

77.5

4.2%

30.0%

$7.9 billion

Arch Coal

51.0

5.2%

76.7%

$5.7 billion

Black Hills (NYSE: BKH)

17.6

6.3%

134.0%

$1.2 billion

Peabody Energy (NYSE: BTU)

25.6

16.4%

61.9%

$16.7 billion

Cloud Peak Energy

10.1

16.4%

99.1%

$729 million

Source: Bloomberg

Cloud Peak Energy’s market cap is less a billion dollars, so it would be the easiest for Buffett to swallow.  But Berkshire Hathaway has $34 billion in cash, so it could buy any of the companies on this list. Hmmm…..

Invest in Coal with the Help of The Energy Strategist

Great minds think alike. Similar to Warren Buffett is Elliott Gue, editor of The Energy Strategist, who is rip-roaring bullish on coal right now. Back in September Elliott wrote a bullish article on coal entitled Coal Stocks: A Top Energy Pick for the Fourth Quarter, in which he argued that increasing Asian demand is the real investment story behind coal:

Investors spend too much time analyzing coal supply and demand trends in the U.S. The truly exciting story is taking place in Asia. Consider the following facts:

  • Chinese electricity generation is up 19 percent in the first six months of 2010, compared to the same period one year ago;
  • Vehicle sales in China are up 48 percent this year, and steel production is up 22 percent; 
  • China’s steel intensity –steel use per capita — is at half or less than that of Japan, South Korea and the U.S., but will ultimately be higher than in the U.S. because Chinese cities are growing up (high-rise, steel structures) rather than out (suburbs);
  • Coal exports to India soared 22 percent in the first half of 2010 and are expected to be up 15 to 20 percent for the full year;
  • and Japanese steel production is up 20 percent this year, and imports of thermal coal have increased 13 percent through May — both signs of a recovery from the 2007-09 recession.

Elliott recommends three coal stocks in his Energy Strategist portfolios, one of which is listed in the table above. Which one is it? To find out the name of his favorite Powder River Basin stock, as well as the other two coal stocks Elliott recommends, give The Energy Strategist a try today!

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