Don't Miss the Opportunity in Peabody Energy

Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Doom and gloom articles about coal are not hard to find. Regardless, reports out of Germany show that coal still has a place in the world. RWE is currently building a coal fired power plant which "can add or shed 600MW in 15 minutes." China and India are planning to greatly increase their consumption of coal and these latest technologies will only make coal more attractive. Peabody is a large miner with mines close to the American and Asian markets. Many miners are trading at a discount, but Peabody is better positioned to supply the growth in the Asian markets with their Australian mines. 

<img src="http://media.ycharts.com/charts/d9fd238555437d0c649ad6a6ea2b6f00.png" />

BTU Return on Assets data by YCharts

Thermal coal 

In the long run demand from China and India for coal is set to grow. This is good news for Peabody Energy (NYSE: BTU) given their assets on both sides of the Pacific. The latest Peabody investor presentation mentions that various types of coal need natural gas prices to be above $2.50/mmBtu to $4.50/mmBtu in order to be competitive. With natural gas prices at $3.50/mmBtu, coal miners are facing short term pressure. Independent analysis of America's fracking boom show that full cycle break even prices are around $7.80/mmBtu to $8.80/mmBtu. Peabody is not Wall Street's favorite pick right now, but the long term picture is more favorable. The company is a global play on coal with a number of mines in the Australian provinces of Queensland and New South Wales. In the United States the company operates a number of mines in the Powder River Basin and the Illinois Basin. As long as natural gas prices stay above $3.50/mmBtu then both of these areas in the U.S. should remain competitive.

Peabody's debt to equity ratio of 1.07 and their profit margin of 7.5% are reasonable. The company currently trades at a P/E ratio close to 9.6 and a price to book ratio of 1.1. Thermal coal has many long term positives and is the company's main market. At these valuations you have the opportunity to buy into a world class coal producer for less than 10 years earnings. Given the strong long term demand from China and slowly increasing natural gas prices, Peabody is a promising investment. 

Firms to avoid

Alpha Natural Resources (NYSE: ANR) sells a mix of metallurgical and thermal coal. In the first 3 quarters of 2012, 44% of revenue was from metallurgical coal, 46% from eastern steam, and 10% from the Powder River Basin. The company is based in the United States but uses a number of ports along the East coast to export a large portion of their production. Over the coming decade it is expected a number of coal power plants will be shut down in the U.S. Their total debt to equity ratio is .59, but their gross margin of 13.2% is relatively low. Their return on investments of -38.0% shows just how far the company has fallen. Asia is the growth market for thermal and metallurgical coal and Peabody's assets in Australia leave it better positioned than Alpha Natural Resources. 

CONSOL Energy (NYSE: CNX) mines thermal coal and natural gas. This exposure to natural gas can be a benefit at times, but when natural gas prices are depressed then Consol is stuck paying the price. As others have pointed out, Consol's guidance of 2012 Q4 gas production hints at the idea that management is trying to keep production down to deal with lower costs. The company is active in a number of shale formations and the high rate of decline of shale wells should give any potential investor second thoughts. Consol's balance sheet is healthy with a total debt to equity ratio of .84 and their gross margin of 34.7% is high relative to their coal peers. Consol's profit margin of 7.8% is only marginally higher than Peabody's 7.5%. Given the large amount of natural gas exposure, Consol Energy is not the best way to play the coal market. 

Arch Coal's (NYSE: ACI) revenue is dominated by thermal coal though it does sell some metallurgical coal. Its mines are found throughout the U.S. and, like other producers, it expects Asia to provide growth. The company's total debt to equity ratio of 1.58 is high, but their quick ratio of 1.30 is reassuring. Their gross margin of 18.1% is only average. Large institutions picked up their bags and left by selling almost 30 million shares in the past quarter. There is nothing in this company to make it especially attractive.

Conclusion

Coal has a negative reputation but the latest power plants are able to use coal in a quicker and more efficient manner. China is installing scrubbers in their power plants which will help to decrease the level of environmental degradation. Peabody Energy has assets in America and Australia and is in a great position to support Asian growth. Fukushima has somewhat decreased the popularity of nuclear which leaves coal as one of the most attractive fuels. 


MrCanadian1 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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