ANALYSIS-High inventories delay U.S. thermal coal recovery

Feb 7 (Reuters) - U.S. thermal coal miners, primed for a recovery in demand, will have to wait for up to a year while stockpiles are run down before profiting from the fuel's return to being the cheap alternative to natural gas in power generation.

Thermal coal is expected to be 35 percent cheaper than gas on average this year, the U.S. Energy Information Administration (EIA) says, reversing a pricing trend that cut coal consumption by 11 percent in 2012 to its lowest level in two decades.

While higher use is good news for coal miners, investors and analysts expect a lag before inventories are cleared and a full-scale rebound begins next year. Their decline, however, is over.

"Most of the coal companies are 'buys' at these levels," said Eric Green, a senior portfolio manager at Penn Capital in Philadelphia. "Much of the bad news for this year has already been factored into the stocks."

Green said he expected Alpha Natural Resources Inc, which closed on Wednesday at $8.67, and Walter Energy Inc , which ended at $36.88, ultimately to rise 50 percent from current levels. But he added: "Not necessarily this year".

Penn Capital, which manages about $6 billion, holds shares in Walter Energy and Alpha Natural.

"We were buying stocks towards the end of last year in anticipation of a better economy in the first and second quarter of this year," said Matthew Peterson, portfolio manager at Newgate Capital Management, which has $1.6 billion in assets under management. "You cannot wait too long."

Peterson, whose firm owns shares in Walter, Consol Energy Inc and Peabody Energy Corp, said coal mining stocks could rise 15 to 20 percent over the course of the next 12 months.

The Dow Jones US Coal Index, which includes shares of Alpha Natural, Arch Coal Inc, Peabody and Consol, has fallen by about a third since January last year.

Apart from weak demand, the re-election of President Barack Obama, a vocal proponent of clean energy who believes in empowering the U.S. Environmental Protection Agency, further weighed on coal stocks.

Natural gas produces half as much carbon dioxide as coal in a power plant, and less than a third as much nitrogen oxide.

"While (Obama is) clearly not a friend of the industry, we think the impact of natural gas prices are far greater for the business than the president or the EPA will be," said Raymond James analyst James Rollyson, noting that some EPA-instituted regulations on coal utilities had been overturned by courts.

Arch Coal Chief Operating Officer Paul Lang said on Tuesday that 2013 would be a "rebalancing" year for coal markets.

"Continued rationalization of high-cost domestic supply, coupled with improved U.S. coal burn, will result in further liquidation of the coal stockpile at U.S. power generators in 2013," Arch Coal said in its results statement.

REDUCING INVENTORIES

Peabody Energy, the world's largest private sector coal company, said last week that it would be "working off inventories through the course of the year".

The U.S. thermal coal inventory at the end of 2012 was 6.5 percent higher than a year earlier, even though many top U.S. coal producers including Arch, Consol and Peabody announced production cuts.

The EIA forecasts thermal coal prices will rise 1.7 percent to $2.44 per million British thermal units (mmBtu) this year, still much lower than $3.74 per mmBtu for gas.

Given that the rise in coal prices will be slight, the main beneficiaries will continue to be companies with low-cost mining operations, such as Consol - rated "buy" or "strong buy" by 21 of 28 analysts covering the company.

Rollyson said he favored coal master limited partnerships (MLPs) Alliance Resource Partners LP and Rhino Resource Partners LP for their "highly contracted portfolios" and said "investors get paid to wait for the recovery".

MLPs are exempt from paying corporate income tax and distribute most of their earnings directly to investors.

Thomson Reuters StarMine's intrinsic valuation model suggests Alliance Resource should be trading at $100.40, while Rhino Resource should be at $23.80, both about 60 percent higher than the stocks' close on Wednesday.

The model takes into account analyst estimates for growth, usually over five years, and then factors in the typical growth trajectory of companies over a longer period.

"With thermal and metallurgical coal price troughs in the rearview, we believe investor attention will be increasingly focused on 2014," Houston-based energy investment bank Tudor Pickering Holt said in a note last week.

(Editing by Robin Paxton)