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Shares of Peabody (BTU) ended Friday's trading session largely unchanged. Shares of the coal producer traded with gains of up to 4% during the morning after commenting on its first quarter outlook.

First Quarter Update

Peabody provided some comments on factors affecting its first quarter and full year 2013 targets. Peabody expects Australian unit costs to increase by approximately 10%, driven by start-up costs at its mines and a higher proportion of higher-cost metallurgical costs. At the same time, the company expects to realize lower metallurgical coal prices compared to the current fourth quarter.

U.S. sales will fall roughly 2 million tons on lower demand and a 5% decline in realized pricing, as a result of the expiration of higher priced contracts.

CEO and Chairman Gregory H. Boyce commented on the outlook:

We are seeing increased U.S. gas-to-coal switching given higher natural gas prices, and global seaborne coal markets are showing signs of improving next year. While the first quarter is challenged due to a combination of factors, we expect quarter-over-quarter improvement throughout the remainder of the year. We also expect to begin realizing the benefits of owner-operator conversion in the second quarter.

Full Year Outlook For 2013

Peabody expects to aggressively reduce its capital expenditures budget for the full year of 2013 by some 50% compared to the current year. The company previously guided for full year 2012 capital expenditures of $1.0-$1.1 billion.

U.S. sales volumes are expected to come in between 180 and 190 million tons, down slightly from the 2012 full year target of 188 to 192 million tons. Australian volumes will increase from 31 to 33 million tons in 2012 to an estimated 33 to 36 million tons next year.

Full year margins at the Australian business will improve from first quarter levels. The transition to operator status and strengthening of metallurgical coal markets will boost margins.

Valuation

Peabody ended its third quarter with $648 million in cash and equivalents. The company operates with $6.36 billion in short- and long-term debt, for a net debt position of roughly $5.7 billion.

For the first nine months of 2012, Peabody generated revenues of $6.06 billion. Peabody generated adjusted EBITDA of $1.42 billion on which the company net earned $427.7 million, or $1.55 per diluted share.

At its third quarter earnings report, Peabody guided for full year adjusted EBITDA of $1.75-$1.85 billion. Adjusted diluted earnings per share are expected to come in between $2.10 and $2.30 per share, on revenues of around $8 billion.

The market currently values Peabody at $7.4 billion. This values the firm at 0.9 times annual revenues, 4.1 times adjusted EBITDA and 12-13 times annual earnings.

Peabody currently pays a quarterly dividend of $0.09 per share, for an annual dividend yield of 1.2%.

Some Historical Perspective

Year to date, shares of Peabody have lost some 16%. Shares started the year around $33 per share and quickly advanced to highs of $39 in February. Shares roughly halved from that point in time as worries about slower global economic growth put pressure on energy prices. Shares recovered in recent months, currently exchanging hands at $28 per share.

Shares of Peabody peaked at levels above $80 per share in 2008, but quickly fell to lows of $20 later that year. Shares recovered to $75 at the start of 2011, but have lost roughly two thirds of their value again from that point in time. Between 2008 and 2012, Peabody increased its annual revenues by roughly 20% to roughly $8.0 billion. The company has been consistently profitable, but saw its debt load increase significantly last year after the acquisition of Macarthur Coal (last year).

Investment Thesis

Shares of Peabody have seen a rough year, despite a strong recovery in recent months. The multi-billion acquisition of MacArthur Coal has been poorly timed, and in hindsight is too expensive given the current market conditions.

Investors were relieved by the relative strong third quarter earnings report in October of the year as revenues rose 4% on the year before. While earnings fell compared to last year, they beat on analysts estimates.

Demand for coal is stabilizing as natural gas prices have inched up from their lows earlier this year. Peabody sees market conditions improving, and the firm also announced a new $100 million cost savings plan, at the time of the third quarter earnings. Cash flows will furthermore improve as the firm aims to cut its capital expenditure budget in half in the coming year, thereby boosting cash flows by approximately half a billion dollars.

The weather remains a short-term worry for investors. A strong start of the winter season caused concerns among investors that the U.S. might face a second warm winter in a row. In recent weeks inventories of natural gas even increased, despite the fact that the winter season is approaching. This weather could put renewed pressure on natural gas prices, and thereby on coal prices.

The company remains well-positioned for a rebound in the coal market. In the short term, investors should expect continued volatility depending on the weather in the coming weeks and months. Leverage is rapidly coming down as the company cuts back its capital expenditure budget, thereby boosting operating cash flows. Shares are fairly valued at the moment, and long-term bullish investors could pick up some shares on dips.

Source: Peabody: Strong Cash Flow Improvements Outweigh Weather Concerns