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Merrier Times for King Coal

Investors bid shares of Arch Coal and Peabody Energy higher Monday on expectations of rising demand for the fuel

Arch Coal (ACI) suffered lower profits during recent months, but investors bought the stock anyway as they looked more favorably at the bigger picture on Apr. 23. The St. Louis company expects to see growing demand for the coal it produces during the coming years.

First quarter 2007 net income amounted to $28.7 million during the three months ended Mar. 31, compared with $60.6 million in the prior-year period. Revenues sank nearly 10% year over year to $571.3 million as coal prices fell. "Market conditions were considerably less favorable in the first quarter of 2007," CEO Steven F. Leer said in a press release Apr. 23.

But Leer expects to build on his results as the year progresses, particularly during this year's second half. The CEO pointed out that the return of more normal weather has already spurred coal consumption during the first three months of the year. Meanwhile supply and demand dynamics in the market are improving. "We believe that an inflection point may have been reached recently in U.S. coal markets," said Leer.

Investors were willing to entertain the idea; Arch stock surged 6.6% to $37.50 per share in afternoon trading on the New York Stock Exchange Apr. 23.

When the summer heats up, people will be plugging in their air conditioners and soaking up electricity. "We believe an inflection point in the coal market is approaching as peak summer demand nears," Standard & Poor's equity analyst Christopher Lippincott said in an Apr. 23 research note. (S&P, like, is owned by The McGraw-Hill Companies.) "We expect electricity demand to continue rising, production to continue slowing, and coal imports to decrease and further tighten supply, which should drive price increases in second half of '07." S&P raised its estimate on Arch Coal's 2007 earnings per share by 2 cents to $1.67 and a 12-month target price by $3 to $45 per share.

Arch backed up its optimistic opinion about supply in the coal market. The company estimates that nearly 11 gigawatts of new coal-fueled electric generating capacity are currently under construction in the U.S., representing more than 40 million tons of incremental annual coal demand to be phased in over the next five years. Another 10 gigawatts are believed to be in advanced stages of development, translating into around 34 million tons of incremental annual coal demand over the same time frame. Between 1997 and 2006, power generators constructed only 4 gigawatts of new coal-fueled capacity, the company says.

More coal generating capacity means more demand for the product Arch digs out of the ground. The company affirmed its guidance for 2007 of diluted earnings per share within the range of $1.25 to $2.00. Analysts surveyed by Thomson Financial were expecting $1.65 per share for the year ended Dec. 2007.

Arch wasn't the only one sounding optimistic about the coal industry. A.G. Edwards analyst Mark Reichman upgraded his rating on Peabody Energy (BTU) to buy from hold on Apr. 23, explaining that the coal maker is poised to benefit from a strong global coal market and improving U.S. coal market fundamentals.

Peabody Energy shares fared almost as well as Arch's on Apr. 23, with a 6.2% gain to $49.45 per share on the NYSE.

(Matt Morrow contributed to this report.)

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