The Bull Case for This Bellwether Coal Producer
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While I don't currently own Peabody Energy (NYSE: BTU) shares it's a bellwether name in the coal sector. The reasons why I don't own it are pretty simple. The company made an ill-fated acquisition of an Australian coal producer last year. Not only did they over pay, but the quality of the coal, called "PCI," is not as good as Peabody's other top notch coking coals in Australia. Operating cost inflation, skilled labor and a strong Australian dollar are additional headwinds.
To be fair, at the time of the deal it may have looked like a good one because coking coal and PCI prices were a lot higher. Peabody was not alone in top-ticking the market last year. In the U.S., Alpha Natural Resources, (NYSE: ANR) bought troubled Massey Energy for an Enterprise Value, "EV" of $8.5 billion. Today the EV of the COMBINED company is just $4 billion. Talk about value destruction! Alpha recently reported a non-cash write-down totaling $2.5 billion.
Another disastrous deal from the heydays of last year was Arch Coal's, (NYSE: ACI) acquisition of Intl. Coal. Like Peabody, Arch way overpaid. Intl. Coal had some good coking coal reserves, but most of the best stuff won't be in production for a year or more. In the meantime, Arch is saddled with $4.5 billion of debt.
I love Walter Energy, (NYSE: WLT), but it too made a questionable acquisition when it purchased Canada's Western Coal. Western had high quality coking coal, but its cost structure was quite high, and the mines were suffering ongoing operating issues. Western's assets are 1,000 kms from west coast Canadian ports. Ok, enough with the ancient history. What about looking forward? Peabody's future is bright, but there's no need to don the sunglasses just yet. Still, one can easily make a bullish case for the company.
When coal prices are in the dumps, no one is doing well. When prices rebound, timing unknown, Peabody will be sitting pretty. The company has aggressive growth plans targeting Asia. For example, Peabody was one of just 3 parties chosen to participate in Mongolia's massive coking coal deposit Tavan Tolgoi. As it turns out, that project is delayed, but that's a good thing given market conditions.
Mongolia could be really big for Peabody 4-5 years from now. In the meantime, Peabody has projects in China that will begin contributing to earnings in the next 2-3 years. An under-appreciated part of the Peabody story is its significant coal trading operations. Not only does this segment generate cash flow, but the market intelligence gathered is quite valuable.
Peabody is best known for its dominance in the Powder River Basin, "PRB" thermal coal arena. Currently spot prices for PRB coal are depressed at levels that are well below cash operating costs. As un-economic mining is idled, PRB coal prices will rebound and Peabody stands to be a main beneficiary. Over time, as export options come to fruition through the Gulf, expansions in west coast ports and planned new ports in the U.S., PRB prices should reach the mid-teens, at which point Peabody will be minting money.
The bull case requires patience, but blue-sky upside from projects in China and Mongolia, as well as robust organic growth in coking coal out of Australia make Peabody a force to be reckoned with. Foolish investors should watch Peabody stock over the next few months. At a price of $20-$21 per share I'm a buyer.
MockingJay2011 owns shares of Alpha Natural Resources and Walter Industries. 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.If you have questions about this post or the Fool’s blog network, click here for information.