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Foundation Coal

Coal
U.S.
November 2, 2007 First Call Note
HOLD Uninspiring Q3 Results; Raising Target by Looking Out to 2009
„ Foundation Coal reported Q3 ongoing results of $0.07 versus the Street at $0.05.
Current Price However, estimates had been lowered in recent weeks after the company
$41.38 preannounced lower Northern Appalachian (NAPP) production.
„ Foundation lowered its forecast range. Its new 2007 forecast is for EPS of $0.75-
Target Price $0.90 versus $0.90-$1.50 previously.
$45.00 „ Foundation had another weak quarter pricing for its new Powder River Basin (PRB)
(Previous: $42.00)
contracts. On the conference call, management said that it was pleased, but not
overwhelmed by PRB pricing. According to our estimates, the company signed new
business at an average of just $10.15/ton in the PRB.
Market capitalization
$1,878 million „ We performed some sensitivity analysis on Foundation based on CONSOL’s recent
bullish pricing comments. If we use $53/ton CAPP steam, $55/ton for NAPP, $77/ton
Shares outstanding high-vol met coal from 2008-2010 (assuming no price inflation), our target price would
46.4 million only move from $45 to $46. This is as a result of Foundation being 93% hedged in
2008, which is the year these prices are well above our estimates, in general.
12-month high/low
$45.55/$29.75 „ We are maintaining our HOLD rating, but raising our target price for Foundation Coal
to $45 from $42. Our valuation is based on a detailed DCF for the coal business, and
Reuters FCL.N an estimated 6.5x 2009 EV/EBITDA multiple for the entire company. We are switching
Bloomberg FCL our EV/EBITDA estimate from 2008 to 2009, as we believe investors are likely to begin
looking at the 2009 markets, with the vast majority of 2008 steam coal already
contracted. Moving to 2009 is the main reason for our increased target price.
„ We are decreasing our 2007-2009 EPS estimates from $1.27, $2.15, and $3.85 to
$0.85, $1.50, and $2.64 respectively. Our lower 2007 estimates account for production
shortfalls (over half a million tons in Q3) in Northern Appalachia. For 2008 and 2008,
we are lowering estimates

YEAR-END EPS NEW EPS OLD P/E DIVIDEND YIELD


DEC ($) ($) (x) ($) (%)
2006A 0.67 0.67 61.8 0.20 0.5
2007E 0.85 1.27 48.7 0.24 0.6
Jeremy Sussman
U.S. Coal Analyst 2008E 1.50 2.15 27.6 0.28 0.7
212-698-3295 2009E 2.64 3.85 15.7 0.32 0.8

DISCLOSURES ARE LOCATED ON THE PAGE PRECEDING THE BACK PAGE STAFF LIST
Foundation Coal

SUMMARY
Foundation Coal beat Q3 by $0.02 on an ongoing basis, coming in at $0.07 versus the consensus estimate of
$0.05. However, estimates had been lowered in recent weeks after the company preannounced lower
production at its Emerald mine in Northern Appalachia on October 3. The weak quarter had already been in
the stock as a result of the company’s October 3 preannouncement of production problems at Emerald.

We are maintaining our HOLD rating but raising our target price for Foundation Coal to $45 from $42.
Our valuation is based on a detailed DCF for the coal business, and an estimated 6.5x 2009E EV/EBITDA
multiple for the entire company. We are switching our EV/EBITDA estimate from 2008 to 2009, as we believe
investors are likely to begin looking at the 2009 markets, with the vast majority of 2008 steam coal already
contracted. This is the main reason for our increased target price.

KEY TAKEAWAYS
Weak Pricing: Foundation had another weak quarter pricing for its new PRB contracts. On the
conference call, management said that it was pleased but not overwhelmed by PRB pricing. According to our
estimates, the company signed new business at an average of $10.15/ton in the PRB, $48.12/ton in NAPP,
$51.50/ton for CAPP steam coal, and $85/ton for CAPP met coal. We view the CAPP prices positively. The
company signed just over 13 million tons total of new business from 2008-2010.

Price Sensitivity: On its conference call last week, CONSOL Energy said that it was seeing prices for 2008
that were essentially much higher than Street estimates. Domestically, for mid-sulfur NAPP coal, CONSOL
was looking at prices from $54-$56/ton. For CAPP coal, management’s estimates were from $52-$54/ton
domestically. For low-vol met coal, CONSOL believes prices are being signed between $95-$97/ton
domestically, or $95-$102 in the export market. For high-vol met coal, CONSOL sees prices at $74-$80/ton
both domestically and overseas. As such, we wanted to see what we would get for a target price, if we
modeled in the midpoint of the above pricing suggested by CONSOL’s management, holding all else equal. If
we use $53/ton CAPP steam, $55/ton for NAPP, $77/ton high-vol met coal from 2008-2010 (assuming
no price inflation), our target price would only move from $45 to $46. This is as a result of Foundation
being 93% hedged in 2008, which is the year these prices are well above our estimates, in general.

Production Problems: On October 3, Foundation announced that it was having production problems at its
Emerald Mine in Northern Appalachia. This was due to geological challenges encountered during the third
quarter. Sandstone intrusions slowed mining and reduced production by about 550k tons in August and
September. Foundation had planned to install a second longwall in the mine in Q4 to offset these geologic
problems, but that has been delayed until 2008. Foundation now projects full year 2007 production of nearly
6 million tons at the Emerald Mine, approximately 600k-700k tons lower than the company's previous
estimate. These estimates still hold true based on today’s earnings release and conference call.

Outlook: Foundation updated its forecast range since the last quarter. Its new lowered 2007 forecast is for
EPS of $0.75-$0.90. It was at $0.90-$1.50 previously. The Street was at $1.06 before Q3 earnings.

Margins: Margins per ton were down by $0.37 from Q2, coming in at $3.69/ton, driven by lower price
realizations. Cost control was actually fairly strong, as costs per ton decreased from $15.74 in Q2 to $15.39
in Q3.

VALUATION
We are raising our target price for Foundation Coal to $45 from $42 based on a detailed DCF for the coal
business, and an estimated 6.5x 2009 EV/EBITDA multiple for the entire company. We are switching our
EV/EBITDA estimate from 2008 to 2009, as we believe investors are likely to begin looking at the 2009
markets, with the vast majority of 2008 steam coal already contracted.

We are decreasing our 2007-2009 EPS estimates from $1.27, $2.15, and $3.85 to $0.85, $1.50, and $2.64
respectively. Our lower 2007 estimates account for production shortfalls (over half a million tons in Q3) in
Northern Appalachia. For 2008 and 2008, we are lowering estimates to primarily to reflect lower-than-

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Foundation Coal

expected realized pricing in the Powder River Basin. In Q2 and Q3, Foundation signed significant tonnage in
the PRB at an average price below $10.50/ton. This pricing is disappointing, in our view.

FOUNDATION COAL DCF VALUATION


($MM) 2007E 2008E 2009E 2010E Terminal
Sales (MM tons) 73.6 73.8 74.8 75.8 NA
Realized Prices ($/ton) 19.8 21.2 22.7 24.9 NA
EBITDA 301.1 350.5 421.8 556.6 514.9
Capex (220.0) (215.0) (240.0) (190.0) (190.0)
Cash Taxes (9.3) (20.7) (37.4) (70.0) (64.8)
Interest Tax Shield Adj (11.0) (11.7) (11.5) (11.3) (11.3)
Working Cap (15.0) (15.0) (15.0) (15.0) (15.0)
Free Cash Flow ($MM) 45.8 88.1 117.8 270.3 233.8

Valuation Summary Statistics


Total EV Firm 2,726.14 WACC 9.2%
less: net debt (638.95) Terminal EBITDA Growth -7.5%
Equity Value 2,087.19 Terminal Year 2011
# shares 46.11 Terminal EV-EBITDA Multiple 6.5
Per Share Value $45.26 PV Terminal CF 2,302.4
Source: Natixis Bleichroeder estimates, company documents

RISK
Economic Sensitivity: We believe the coals are highly dependent on electric demand, which is in turn
dependent on economic growth (GDP, employment, and industrial production). If the economy moves into a
recession, this would negatively affect demand in the coal sector.

Operational Shortfalls: The coal industry is subject to operating risks in the form of unexpected production
shortfalls, transportation challenges, and swings in its feed stocks (e.g., tires, diesel, equipment, explosives,
and steel roof bolts).

Regulatory Changes: The coal industry is subject to changes in safety regulations (especially given the
accidents in 2006) as well as regulations governing its principal customers, the electric utilities. The long-
term thesis for coal is dependent on the construction of new baseload coal plants being constructed —
permitting challenges could delay or prevent this future demand catalyst.

Demand: The coal industry is subject to factors that drive overall electric demand such as weather and
economic growth. Weaker-than-expected conditions could result in lower-than-expected demand and pricing
as experienced in 2006.

Volatility: Coal equities have traded with a high degree of volatility (average beta of 1.62 versus the S&P
500) and tend to move with overall energy sentiment.

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Foundation Coal

TARGET PRICE HISTORY

Full reports of covered companies are available on request.


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The views expressed in this report accurately reflect the personal views of the author(s) of this report. The author(s) of this report
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not rely upon this Communication.
NBI RATING DEFINITIONS % OF STOCKS COVERED % IB SERVICES
BUY: potential return is >15% above the current price 58% 18%
HOLD: potential return is -15% to +15% of the current price 34% 2%
SELL: potential return is >15% below the current price 8% 0%
© 2007 Natixis Bleichroeder Inc. All rights reserved. Printed in U.S.A. Reproduction or quotation in whole or in part without prior written permission by Natixis
Bleichroeder Inc. is forbidden. All information in this report is subject to change at any time without prior notice. The information contained herein, while not
guaranteed, has been obtained from sources we consider reliable. This information is taken from company reports and documents and/or Natixis Bleichroeder Inc. or
any of its affiliates’ estimates, unless otherwise noted. This is not a solicitation of any order to buy or sell. Past performance is not indicative of future results.
Additional information is available upon request from Natixis Bleichroeder Inc., 1345 Avenue of the Americas, New York, NY 10105 / 1-212-698-3000.

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