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Massey Mining Accident: How Asia's Demand for Steel Will Save Massey and Boost Its Competitors

Last Updated Apr 7, 2010 2:22 PM EDT

How is it possible for a company like Massey Energy, owner of the Upper Big Branch coal mine in West Virginia where an explosion killed 25 people, to appear undervalued? The government and the public -- let's not forget the lawyers -- will be gunning for Massey, especially in light of the 3,007 safety violations and more than $2.2 million in fines already assessed against this particular mine since 1995. Lawmakers are already calling for stricter mining rules, which could raise costs for coal producers.

Massey's image will certainly take a hit. At the moment, the accident is the worst in more than two decades. If the four missing miners are found dead, it will be the worst mining accident since the 1970s. Environmentalists, who abhor Massey, already put the company and its controversial CEO Don Blankenship somewhere in the seventh circle of Dante's Inferno.

And yet, some analysts, including Jefferies & Co., have maintained that Massey Energy is undervalued. Here's why they're right and why Massey will end up recovering sooner than we all might expect and in spite of the coming regulatory and legal storm.

It all comes down to Asia's recovering appetite for steel. Steelmakers need metallurgical coal, which Massey just so happens to produce (along with quite a bit of thermal coal, as well). A combination of improved demand for steel and an expected shortage has pushed steelmaking coal prices up considerably. Steelmakers in Asia, the American Metal Market noted, agreed to a 55-percent increase in prices of hard coking coal for the April-to-June quarter to $200 per ton.

Massey, realizing the opportunity to cash in on the tight met coal market, has ramped up production at its met coal mines and started to develop new ones. Upper Big Branch, for example, was on target to raise production by more than 66 percent to 2 million tons. And just last month, Massey offered $960 million in cash and stock to buy Cumberland Resources, a privately held company that holds some 416 million tons of coal in reserves -- half of which can be used as met coal.

Clearly, the Upper Big Branch mine won't be producing coal for some time. Meaning, about 16 percent of Massey's planned steelmaking coal shipments will be taken off the table. At first glance, it looks like Massey will lose money if the mine is closed. And it will. But the company won't take as big a hit thanks to a tightening met coal market and strong margins. Taking the Upper Big Branch mine offline will reduce supplies of the steelmaking coal -- at least in the short term -- and that will only push prices higher.

Which means while Massey will survive, its met coal competitors will benefit greatly. Shares of Walter Energy (WLT) Alpha Natural Resources (ANR) and Patriot Coal (PCX) all hit 52-week highs Tuesday, before falling back a bit. As the met coal market tightens expect more than shares to rise. Profits will too.

Photo of a smoke stacks next to coal from Flickr user, Sierra Club, CC 2.0