Has This Giant Bottomed Out?

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

Low coal prices have been the major culprit behind a waning coal industry. Peabody Energy (NYSE: BTU), the world’s largest private coal company, has been no exception to the declining coal sector. On July 3, 2013, Peabody’s shares closed at a mere $14.65, showing a 43% fall on a year-over-year basis.

With Peabody’s share price plummeting, two key questions come into mind: Has Peabody Energy bottomed out? When will it rise again?

Limits on Carbon dioxide emissions

In order to combat long-term effects of global warming, President Obama put limits on carbon dioxide emissions from power plants. This would help in reducing carbon emissions by 17% from 2005 to 2020.

This new rule means higher operating costs for coal power plants. Hence, the power generating companies would be hesitant using coal for electricity purposes. As a result, natural gas would be the likeyl choice for the energy industry going forward. Peabody, being the largest private sector coal company in the world, is bound to be affected by this regulation. Preference of natural gas over coal for power generation would further weaken coal’s demand and price, which would have an adverse effect on the company’s revenue.

Peabody slashes Australian jobs

In an attempt to lower operating costs, Peabody plans on cutting 450 contractual jobs at its Australian mines. According to Peabody’s President, Charles Meintjes, “(Contractors have) traditionally been an area of high spend for the company and as a result we will be reducing approximately 450 contractor positions at our mines over the coming weeks.” These job cuts are expected to take place in Queensland and New South Wales, where both thermal and coking coal is produced.

This latest move suggests that Peabody’s management doesn’t expect coal prices to recover in the near future, which is yet another setback for the company.

Australian Dollar and Peabody Energy

For the last couple of years, a strong Australian dollar (AUD) meant high operating costs for Peabody Energy in Australia. Conversely, a weak U.S. dollar (USD) resulted in lower revenue for the company. However, during the last three months, AUD has lost almost 10% of its value, relative to the USD. This comes as a relief for Peabody, which has a major group of coal mines in the region, as a strong USD would translate into more revenue for the company.

EIA energy outlook

The only good news for the coal industry comes from the U.S. Energy Information Administration's outlook for 2013. According to EIA, U.S. coal consumption will grow 7.1% in 2013 amid higher electricity demand and higher gas prices.

In 2012, mild winter was one of the core reasons behind low natural gas prices in the U.S. In 2013, normal temperatures are expected in most parts of country, which would drive gas prices in the winter season. This would make coal-fired electricity a preferred choice for power generators, creating more demand for thermal coal during winters. 

Valuation

Peabody is trading at a forward P/E of 14.95 times and is yielding a dividend of 2.30%. The company’s latest quarterly results depict that its sales went down almost 14% on YOY basis. For the year, sales (ttm) have gone down 4.5% in comparison to the previous year. A beta of 1.52 reflects that the company is hugely cyclical and moves in accordance with market conditions. Peabody’s ROE of -12.69%, in comparison to industry’s ROE of -8.49%, is a testimony to this. The company’s price-to-book value (P/BV) of 0.81 states that it is trading at a price that is almost 20% less than its intrinsic value.

The bulls are of the view that, since Peabody is trading far below its book value, it has almost bottomed out. But, the fact is that, if coal prices don’t recover in the near future, Peabody’s share price has nowhere but to go down further.

Coal industry’s major players

The American coal mining and processing giant, Arch Coal (NYSE: ACI), is the second-largest supplier of coal in the U.S. The company accounts for more than 16% of the country’s domestic market. Just like Peabody, Arch has been hit hard by the declining coal prices. On the July 3, 2013, the company’s shares closed at $3.72, 48% less on a YOY basis. In its most recent quarter, the company reported a 21% slide in its sales as compared to the same quarter last year. Sales (ttm) for the year were down by 11%. Arch is yielding a dividend of 3.23% and has a ROE of almost -28%. A negative PEG of 0.55 and a mean recommendation of 2.8 suggest that Arch isn’t a good buy at the moment.

On the other hand, the top coking coal producer, Alpha Natural Resources (NYSE: ANR), has been keen on curbing its costs in order to outmaneuver the weak coal market. Thanks to its aggressive cost-cutting, Alpha reported a lower-than-expected loss in the first quarter. Considering this, there’s still a lot of room for improvement for the company. A negative ROE of 41% and an ROI of -19% shows that Alpha is among the hardest hit by low coal prices. A super high beta of 1.95 shows its dependence on economic factors. A negative PEG of 0.46, plus a mean recommendation of 2.7 on the sell side, doesn’t make it an attractive buy at this stage.

Conclusion

The future of Peabody, and the coal industry, rests on global coal prices. Unfortunately, coal prices won’t recover that much in the near future, making it hard for the industry to mint substantial incomes. The new carbon dioxide limits in the U.S., along with the latest ban on coal imports in China, would further pressurize the global coal prices. Moreover, China’s rising steel exports would drive steel prices down, causing another dip in met coal prices. In other words, coal prices are expected to slide even further in the coming months. Hence, Peabody Energy hasn’t bottomed out yet.

Cold winters in the U.S. would make coal slightly cheaper than natural gas, giving an impetus to thermal coal demand. This would increase thermal coal’s price to some extent. Therefore, until November, 2013 (start of winter season in the U.S.), things don’t look pretty for Peabody Energy.

If you're on the lookout for some currently intriguing energy plays, check out The Motley Fool's "3 Stocks for $100 Oil." For FREE access to this special report, simply click here now.


Waqar Saif 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!

blog comments powered by Disqus