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Arch Coal: Burning Brightly

Coal stocks are on fire, but there's more excitement ahead because of high coal prices, high demand, and tight supplies.

Shares of Arch Coal (symbol ACI) have doubled in a year, to $86, but they still have plenty of room to run, says Lehman Brothers analyst Peter Ward. He just boosted his one-year price target from $90 to $120 and his earnings estimates for the next few years because he's convinced that Arch can lock in even higher prices for coal it delivers to utilities through at least 2008.

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Arch has mines in several regions, but it is best known for ultra-low-sulfur coal from Wyoming's Powder River Basin, where Arch gets two-thirds of its production. Electric utilities prize this coal because it is mined cheaply on the surface and, as coal goes, it is clean to burn.

Ward is also high on the shares of Peabody Energy (BTU) and Foundation Coal (FCL), which also have operations in the same area of Wyoming. Peabody and Arch are among the industry's giants, while Foundation is considerably smaller. Since its initial public offering in December 2004, Foundation shares have doubled, to $46. Ward just upgraded his view of Foundation to "overweight," the same rating he assigns Arch and Peabody. His new one-year target for Foundation is $60.

Arch and Foundation report quarterly earnings next week, but analysts don't expect any shocks. Peabody, whose shares are set to split two-for-one later this month, reported good quarterly results in January.

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Looking at the big picture, shares of coal companies, especially those with major operations in Wyoming and Montana, should perform well in coming years. Earnings should grow strongly as more utilities purchase additional western coal. Coal produced on the surface from the western plains is much more profitable per ton (on a percentage basis) for coal companies than coal extracted from deep beneath Appalachian hills. Also, as natural gas gets so scarce that the U.S. turns to imports, coal will play an increasingly bigger role in U.S. power generation. Coal may not be the most popular industry -- but it's an essential one and, for investors, an often overlooked one.

--Jeffrey R. Kosnett

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