How To Play The Chinese Coal Boom

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

The Chinese coal boom appears to be continuing to grow, despite some concerns the market could be slowing. Part of the concern has been related to the rising inventories of coal in China, which have led to lower coal prices. However, China continues to be a driving force behind the global rise in coal consumption, burning almost as much coal as the rest of the world.

<img src="/media/images/user_15651/col_large.png" />

Source: Washington Post

One of the best positioned coal companies, based on valuation and resource bases, to capitalize on this is Peabody Energy (NYSE: BTU). Peabody’s Australian coal assets are well positioned to provide coal to China, and the company is looking to increase its exposure to Chinese coal even more, with the consideration of the purchase of resources in Mongolia.

Peabody is still rebounding from the environmental regulations and mining costs that have been straining the Appalachian region, pressures that have pushed the stock down 35% over the last twelve months. This stock decline may well have positioned Peabody as an undervalued coal play (read more about Peabody here).

Last quarter results came with a positive outlook. EPS came in at $0.51 on the back of sales volume up 6%, compared to Wall Street EPS estimates of $0.34. Part of the attribution for the outperformance was an increase in the Australia segment, which is the same segment that should see boosts from increasing China demand.

Coal demand

The outlook for China demand is positive and should help drive the industry. Peabody expects global economic growth and China's infrastructure spending to lead the way for volume growth in coal demand of 10% to 15% in 2013. What’s more is that energy consulting firm Wood Mackenzie believes that coal will overtake oil as the world’s largest energy source in 2013. The trend is expected to continue over the interim. Chines consumption, in tonnes, is expected to increase by 17% over the next four years:

<img src="/media/images/user_15651/chian-coal_large.jpg" />

Source: Peabody Analytics

Industry comps

Major Peabody peers include Alpha Natural (NYSE: ANR), Arch Coal (NYSE: ACI), Walter Energy (NYSE: WLT) and CONSOL Energy (NYSE: CNX). U.S. coal producers have been decimated due to lower coal prices, namely Alpha and Arch. The two stocks have been down over 60% during the last twelve months. This has resulted from the oversupply of natural gas, and the drop in natural gas prices. Analysts expect Arch and Alpha to post increasing earnings losses per share in 2013. 

One of the coal producers with the best 2013 earnings growth profile is Consol Energy, which produces coal and natural gas, and expects production to increase between 8% and 15% for the year. Consol has actually been redirecting away from coal, selling off $350 million in coal assets in 2012, and expects to sell between $127 million and $312 million in 2013. 

Walter’s entry into the prospective Latin American steel markets will increase its growth opportunities. The company is also maintaining a solid balance sheet that will help it remain flexible, with cash of $129 million on hand and generating third quarter operating cash flow of $333 million.

Peabody is also reasonably priced in comparison to other top coal companies Walter Energy and Consol:

<table> <tbody> <tr> <td> </td> <td> <p><strong>Peabody</strong></p> </td> <td> <p><strong>Alpha Natural</strong></p> </td> <td> <p><strong>Arch Coal</strong></p> </td> <td> <p><strong>Walter Energy</strong></p> </td> <td> <p><strong>Consol</strong></p> </td> </tr> <tr> <td> <p><strong>Price to Sales</strong></p> </td> <td> <p>0.8</p> </td> <td> <p>0.3</p> </td> <td> <p>0.3</p> </td> <td> <p>0.9</p> </td> <td> <p>1.4</p> </td> </tr> </tbody> </table>

Making Peabody even more appealing is its top-in-industry profitability:

<table> <tbody> <tr> <td> </td> <td> <p><strong>Peabody</strong></p> </td> <td> <p><strong>Alpha Natural</strong></p> </td> <td> <p><strong>Arch Coal</strong></p> </td> <td> <p><strong>Walter Energy</strong></p> </td> <td> <p><strong>Consol</strong></p> </td> </tr> <tr> <td> <p><strong>EBITDA Margin</strong></p> </td> <td> <p>23%</p> </td> <td> <p>12%</p> </td> <td> <p>14%</p> </td> <td> <p>22%</p> </td> <td> <p>19.50%</p> </td> </tr> </tbody> </table>

Don’t be fooled

Peabody is the world's largest private sector coal miner and expects earnings to rise due to higher volumes and prices at its Australian mines, with the main driver being rising Chinese coal demand. The stock currently trades around $23 to $24, but Wall Street analysts have a $32.50 price target on the company, suggesting upside of nearly 35% (check out which hedge funds love Peabody).

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