A coal company you can really dig

The spike in natural gas prices has created an opportunity for Peabody.

By MoneyShow.com Jun 25, 2013 1:04PM
 Elevated view of freight cars with coal copyright Joseph Sohm-Visions of America, Photodisc, Getty ImagesBy Elliott Gue, Energy & Income Advisor

Shares of coal producers have languished this year, and remain out of favor with investors. But our favorite coal miner's stock trades at a deep discount and stands to benefit from several upside catalysts in the back half of 2013.


In the U.S., prices for thermal coal have benefited from the rising price of natural gas. The no-show winter of 2011-2012, coupled with robust production, sent natural gas prices spiraling to $2 per million British thermal units, prompting a wave of coal-to-gas switching among utilities.


On an energy-equivalent basis, thermal coal from all the major producing areas in the U.S. is less expensive than natural gas.


Peabody Energy (BTU), which boasts core operations in both the Central Appalachia and Powder River Basins, will benefit from utilities switching back to coal from natural gas. Gregory Boyce, CEO of Peabody Energy, acknowledged as much during a conference call to discuss the company's first-quarter results:

"We've seen a dramatic improvement in coal fundamentals from this time last year. We now project 60 million to 80 million tons of increased coal demand in 2013, as the industry reclaims the majority of demand lost in 2012 to natural gas.
"Within the US markets, winter was 17% colder than last year. And natural gas prices have more than doubled from last April, driving a 15 million ton increase in the first-quarter coal burn at the same time that gas generation dropped 11%.
"Coal now accounts for approximately 40% of total generation, while gas has fallen to 24%. The supply side of the equation was also favorable in the first quarter, as US coal shipments fell 10%.
"The end result is that PRB and Illinois Basin stockpiles have improved 20% over the last year. And over the next five years, we expect the low-cost PRB and Illinois Basin demand to grow more than 125 million tons through greater capacity utilization and regional switching. "


Peabody's exposure to pulverized coal injection (PCI) is another advantage. With steel producers looking to reduce costs, they've experimented with using more PCI and less metallurgical coal in their furnaces.


In 2012 the price of a metric ton of PCI averaged about 69% of the cost of a metric ton of hard coking coal. Today, this ratio has increased to 80%, thanks to robust demand for PCI.


Moreover, Peabody Energy's operational performance continues to improve. Management has delivered on its promise to reduce first-quarter Australian mining costs by 10% from year-ago levels. Peabody also lowered its full-year guidance for production costs Down Under to $80 per metric ton from the low $80s.


Peabody paid down $100 million of debt in 1Q 2013 and another $100 million at the end of May, closing in on its goal of repaying $600 million in debt this year. The stock has suffered in recent years because of concerns about the leverage taken on to finance its late 2011 MacArthur Coal acquisition.


With a dividend yield of 2% and a stock price roughly on par with book value, Peabody represents a deep-value play on an eventual recovery in coal markets. Although potential downside appears limited at these levels, investors should note that this trade entails higher risk and could take time to play out.


Subscribe to Energy & Income Advisor here.


More from The MoneyShow

0Comments

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

104
104 rated 1
252
252 rated 2
457
457 rated 3
639
639 rated 4
495
495 rated 5
538
538 rated 6
704
704 rated 7
503
503 rated 8
350
350 rated 9
140
140 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
UPLULTRA PETROLEUM Corp10
EOGEOG RESOURCES Inc10
TAT&T Inc9
COPCONOCOPHILLIPS9
DVNDEVON ENERGY CORPORATION9
More

VIDEO ON MSN MONEY

ABOUT

Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.