Peabody Energy: Value Play or Value Trap?

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

Peabody Energy (NYSE: BTU) management recently offered an optimistic outlook for coal in 2013.  The company expects improving conditions in several areas after a weak first quarter.

First, rising natural gas prices are reversing the coal to gas trend in electrical generation. Second, Peabody expects to lower capital expenditures in 2013 by 50% versus 2012 capex costs. Third, the outlook for international coal exports is improving. Recent data shows economic conditions in China are getting better.

As we approach the end of a miserable trading year for coal stocks, BTU shares have started rising up in December. However, whether this momentum can continue or not in the long term depends on several factors.

Future Prospects

In August 2011, Peabody acquired Macarthur Coal, a major Australian coal producer.  Australia is the leading metallurgical (coking) coal exporter in the world.  Peabody now derives 40% of its revenue from its Australian operations.  Forecasted demand for electrical generation in the Asia Pacific region is increasing. ExxonMobil’s Energy Outlook 2012 report predicts a 50% increase in demand for electricity by 2040. Developing countries account for most of the increase.  Peabody is positioned to benefit. The report states coal will remain in the energy mix, but natural gas will show the greatest growth.

Natural gas may lose its recently gained cost advantage over coal. However, there is no denying natural gas is a cleaner burning fuel. The forecasts you read for the future of coal assume existing technologies. However, Peabody is a leader in developing clean coal technologies. Game changing technology in the coal sector is something to watch for. There are those who doubt clean coal is possible. However, technological improvements can always happen. It is worth to remember how hydraulic fracturing technology has revolutionized the energy outlook in the U.S. in less than a decade.

Peabody vs. the Rest

Peabody is a pure play in the coal sector.  As such, one would expect the company to have underperformed competitors with diversified resource assets. Australia-based BHP Billiton (NYSE: BHP) is the world’s largest diversified miner.  Their largest revenue stream is iron ore. The company also mines coal, diamonds, uranium, and has oil and gas assets as well. U.S.-based CONSOL Energy (NYSE: CNX) is a major coal producer with natural gas operations as well.  The following table looks at some key performance metrics for Peabody and these competitors:

<table> <tbody> <tr> <td> <p><strong>Indicators</strong></p> </td> <td> <p><strong>Peabody Energy </strong></p> </td> <td> <p><strong>BHP Billiton </strong></p> <p><strong> </strong></p> </td> <td> <p><strong>CONSOL Energy</strong></p> </td> </tr> <tr> <td> <p><strong>Market Cap</strong></p> </td> <td> <p>$7.2 billion</p> </td> <td> <p>$207.7 billion</p> </td> <td> <p>$7.7 billion</p> </td> </tr> <tr> <td> <p><strong>Trailing P/E</strong></p> </td> <td> <p>9.2</p> </td> <td> <p>13.4</p> </td> <td> <p>18.0</p> </td> </tr> <tr> <td> <p><strong>Forward P/E</strong></p> </td> <td> <p>14.4</p> </td> <td> <p>16.21</p> </td> <td> <p>28.12</p> </td> </tr> <tr> <td> <p><strong>Price/Book</strong></p> </td> <td> <p>1.2</p> </td> <td> <p>1.88</p> </td> <td> <p>2.0</p> </td> </tr> <tr> <td> <p><strong>Earnings Growth (Quarterly)</strong></p> </td> <td> <p>Negative</p> </td> <td> <p>Negative</p> </td> <td> <p>Negative</p> </td> </tr> <tr> <td> <p><strong>Dividend Yield</strong></p> </td> <td> <p>1.26%</p> </td> <td> <p>2.9%</p> </td> <td> <p>1.47%</p> </td> </tr> <tr> <td> <p><strong>Debt/Equity</strong></p> </td> <td> <p>1.1</p> </td> <td> <p>0.3</p> </td> <td> <p>0.8</p> </td> </tr> <tr> <td> <p><strong>Return on Equity</strong></p> </td> <td> <p>11.4%</p> </td> <td> <p>25.1%</p> </td> <td> <p>12.0%</p> </td> </tr> </tbody> </table>

Data as of Dec. 20

Looking at valuation metrics only, Peabody emerges as the best prospect in this batch. With both the trailing and the forward P/E under 15, Peabody merits attention. It is interesting to note that despite the diversification, Peabody’s earnings growth was less dismal than the others. While the company’s ROE of 4.08% is respectable, debt to equity ratios over 1.0 are also cause for some concern.

Foolish Summary

Peabody is a world leader in coal production with a low cost producer advantage.  The company’s Australian operation gives it a major advantage in serving the demands of Asia-Pacific customers. Analyst opinion on Peabody is moderately bullish. For investors with risk tolerance, Peabody Energy may be an attractive short to mid-term play.

The fact that it's relatively diversified suggests the company can withstand competition from natural gas for quite some time.  Long-term investors might be attracted by the company’s solid dividend performance over time.  However, the extremely cautious investor might want to wait for more certainty on the future of coal versus natural gas and other forms of alternative energy.

So whether Peabody Energy is a value play or value trap depends on the future of coal demand. Currently, the prospects does not look bright for coal stocks, but we might observe some strong recovery in the new year. 

ecofinstat has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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