With coal stocks now out of favor, we thought it would be fitting to look at a few names in the sector that are poised to snap back. Coal has faced several headwinds over the last few months, such as slowing international growth and declining natural gas prices. At this point, these stocks have gotten too cheap to ignore.

Here is a brief break down of why the world needs more coal:

South America: Port infrastructure constraints have affected supply, and the region as a whole has increased its regional coal burn.

U.S.: The U.S. is a swing supplier to the Atlantic basin market. As available coal export capacity increases, imports into countries is declining.

Europe: European coal production has been declining as growing Eastern Europe burns more coal.

Russia: Production challenges have limited Russia’s once-dominant position in the market. Only U.S. producers are able to pick up Russia’s slack.

South Africa: South Africa is facing domestic power and needs all of the coal it can get. Generally speaking, reserves have been degrading as exports shifted to the Asian/Pacific market.

Australia: Severe port and rail bottlenecks have underlying labor and mine challenges.

Indonesia: Indonesia is experiencing increasing domestic demand as export capacity is dependent on congested river system.

China: Substantial growth in domestic demand will likely push China to be a net importer by as early as 2008.

Vietnam: Vietnam may cut coal exports to meet domestic demand. It is reported that Vietnam may cut overall exports of the fuel by 89% by 2015 to satisfy rising domestic demand.

India: Imported coal needs projected levels to rise meaningfully. India will pull available supply from Atlantic Basin markets.

Jefferies just upgraded the sector saying that “current valuations do not reflect robust earnings growth potential."

Here are a few names in the sector that you want to pay attention to.

International Coal (ICO): West Virginia-based International Coal is a large producer of metallurgic coking coal, which is used as a reducing agent in smelting iron ore and is an essential element in the manufacturing of steel. The company has increased metallurgical production from 100,000 tons in 2006 to 2 million tons in 2008. And forecasts show that by 2010 the company will produce 2.6 million tons. Year over year, its international per-metric ton prices have increased substantially. In fact, its largest international consumers, such as India, China and Russia, are having massive coal shortages, which are forcing sharp increases in imports. With 94% of its 2008 orders committed, these additional orders will definitely boost future revenue. The company is scheduled to report first-quarter earnings after Wednesday's market close. Its shares have lagged the coal sector overall since its initial public offering two years ago, and with a 15% short position, the stock could see a nice move up.

Noted value investor Wilbur Ross has a large stake in International Coal.

Arch Coal (ACI): By 2012, the world will need an estimated additional 1.1 billion short tons of new coal supply; Arch Coal is the play off this long-term trend. Arch Coal provides cleaner-burning, low-sulfur coal to fuel about 6% of the nation’s electricity and roughly 12% of the nation’s coal supply.

Patriot Coal (PCX): Patriot Coal was spun off from Peabody Energy (BTU) on Oct. 31, 2007. Patriot has multiple coal basins with a wide range of products of both surface and underground products. Patriot Coal is the third-largest Eastern U.S coal producer and marketer, with 71% of its 40.4 million tons sold coming from Central Appalachia, 19% from the Illinois basin and 10% from Northern Appalachia. Year-to-date margins per ton improved 56%, while second-quarter margins improved 82%. Patriot recent bought Magnum, another high-growth coal producer. Magnum has substantial reserve bases with long reserve lives of 30 or more years with high-quality thermal and metallurgical coal. The big thing here is that more than 40% of its 2009 balanced contract backlog is not fixed in terms of price. Given the strong pricing environment and demand for coal, Patriot's recent merger with Magnum makes a lot of sense.

Other names to look at include Peabody, National Coal (NCOC), Massey Energy (MEE) and Cons Energy (CNX).

Posted on Sept. 15, 2008