The Best Investment in Coal

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Traders are extremely pessimistic regarding the growth of China over the next year, and this has led them to dumping their positions in coal, into the market. This has led to an oversupply of coal, which is pushing down its market price. Coal is one commodity amongst many that reflects the health of the global economy. The latest stimulus package by the Federal Reserve Bank, Japan, and China could increase infrastructure spending meaning an upside for coal and iron ore. For investors looking to avoid the volatility in the prices of coal, Peabody Energy (NYSE: BTU) could turn out to a great investment, and here are a few reasons why.

About the company

Peabody Corporation is one of the largest coal producing companies in the world. The company with a market cap in excess of $6.5 billion has its operations in 25 countries in 6 continents and is also involved in steelmaking. In 2010, the company recorded sales of 246 million tons of coal. The company that was listed in the Fortune 500 has revenues in excess of $7.9 billion and total assets in excess of $16.7 billion.

The industry outlook

Federal Reserve Bank announced that it will be injecting liquidity into the market by buying $40 billion of mortgage securities every month along with a plan of buying $85 billion worth of country’s bonds monthly. To ensure the added liquidity results in an increase of infrastructure projects, the interest rates would be kept low till at least 2015. Now, coal is a commodity whose pricing directly depends upon the economic growth prospects of the major countries across the globe. With China’s $156 billion infrastructure development plan, and Japan’s $1 trillion stimulus package, coal looks well poised to gain its ground back.

Rising Demand?

It’s also worth noting that the consumption of coal has increased as coal based power plants are being preferred over the more expensive natural gas based power plants. The consumption of coal is up around 5% in Germany as the country now prefers coal based energy over nuclear power. Globally countries are shifting to coal based power plants because of its cheap pricing. And it is because of these reasons, coal now accounts to around 31% of the global energy consumption.

Analysts expect the demand of growth to increase at the rate of 25% every year as developing nations try to reach their growing energy demands.

The company expects an addition of 90 gigawatts of coal based electricity generation in 2012, and an addition of 390 gigawatts of coal fired electricity generation by 2016. Besides electricity generation coal is also used majorly for metallurgical and smelting purposes, of which the demand is expected to increase by 25% each year by 2016. If the global growth engine gets running back up, coal producers will be seen making tons of money.

The fundamental gameplay

Peabody Energy Corp faces competition from Alpha Natural Resources (NYSE: ANR), Arch Coal (NYSE: ACI) and Consol Energy (NYSE: CNX).

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>Yield</strong></p> </td> <td> <p><strong>ROI</strong></p> </td> <td> <p><strong>Net Profit Margin</strong></p> </td> <td> <p><strong>EPS growth next yr.</strong></p> </td> </tr> <tr> <td> <p><strong>Peabody</strong></p> </td> <td> <p>6.98x</p> </td> <td> <p>1.39%</p> </td> <td> <p>7.44%</p> </td> <td> <p>11.33%</p> </td> <td> <p>19.4%</p> </td> </tr> <tr> <td> <p><strong>Alpha Natural Resources</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>0%</p> </td> <td> <p>-21.7%</p> </td> <td> <p>-36%</p> </td> <td> <p>-14.3%</p> </td> </tr> <tr> <td> <p><strong>Arch Coal</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>1.69%</p> </td> <td> <p>-3.8%</p> </td> <td> <p>-7.8%</p> </td> <td> <p>4.7%</p> </td> </tr> <tr> <td> <p><strong>Consol Energy</strong></p> </td> <td> <p>11.7x</p> </td> <td> <p>1.6%</p> </td> <td> <p>5.6%</p> </td> <td> <p>10.3%</p> </td> <td> <p>9.55%</p> </td> </tr> </tbody> </table>

After comparing the metrics of the 4 competitors, we are able to deduce that Peabody enjoys the highest net profit margins amongst the peers and yields 1.39%. The returns on the company’s investments were also the highest, and analysts expect the next year’s EPS growth to be around 19.4% which is again the highest amongst the peers. The shares of Peabody trade at 6.98x P/E and 0.38x PEG which indicates that the stock is undervalued, which finally turns out to be our fundamental pick.

Conclusion

Though we do not know whether the coal prices have already bottomed out or not, what we do know is that the prices are in the process of bottoming out. It’s a fact well known to all that due to the falling demand of coal, all the major coal producers took a beating in the markets along with Peabody. To add to it, the company had lowered its guidance for the financial year 2012, but at that point of time, the stimulus packages weren’t announced. We believe that the industry has a huge potential to grow, and looking at the fundamentals, Peabody Energy Corp appears to be a sound investment choice.

 


PiyushArora 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.If you have questions about this post or the Fool’s blog network, click here for information.

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