Today I am going to start a weekly segment that will highlight a company doing business within the energy sector. I will analyze the company and offer insight on appropriate trading and investing strategies I like that involve this particular company and why. I may revisit to review opportunities for improvement as well as highlight the positive results of my call.
Why not begin with the world's largest coal producer, Peabody Energy Corporation (BTU)? This company, which is down over the past 18-months in a bad way, is definitely worth buying. What is happening to the stock, why has it been getting battered? The future of coal is unclear, we caught a glimpse during the election where both candidates beat coal into the ground. Also, demand from China decreased in 2012. These and other factors created heavy negative momentum for this stock and investors are starting to realize how oversold BTU has become. Going back just as far as 2011, when the stock was over $70, Peabody had record breaking revenues and the global demand for coal is looking strong again as we forge ahead in 2013. This is largely the same Peabody, still positioned to harness the growth in global demand, still the world's largest coal producer, and now might be the right time to get fired up about Peabody Energy again as its RSI (10,1d) nearly hit the floor Friday to 6.63 indicating the stock is oversold.
Many analysts have called higher price targets and moved to buy recommendations as the stock price has fallen, yet it continues to fall even as evidence of increased global demand hit the press. The fact is, China is an enormous part of the success for Peabody and other coal producers. As manufacturing slowed in China, Peabody's earnings were hit and investors fled for capital protection and yield, 2012 was not a good year for Peabody in those respects. However, looking forward from the bottom, it seems that most of the weakness is behind Peabody.
Since the election, this company has been battered, down over 26% from November 1st, 2012, to March 1st, 2013. Obama and many even outside his coalition have has scared investors away from coal, fortunately for buyers of this company, demand for coal remains intact. While I am bullish on Peabody, I don't think we will visit the 2011 highs in the near term, more reasonably we will at the very least retrace half of the November highs, currently this would be an increase of about $4.64 to $25.20 and I think this should occur as April's earnings approach. Despite the president in office, Peabody is a global coal leader and we are in an environment that is experiencing growth in global coal demand. Down to the simplest analysis, the stock is oversold and fundamentally poised to lead the failing coal industry as it now begins its recovery.
I would not argue that there is significant risk associated with coal in the very long term domestically as our government attempts to reach clean energy standards and renewable energy sources. I would scoff at anyone who seriously thought that Peabody should at all be concerned about this in the near term. Demand for coal is still very high, while natural gas is potentially going to see an increase in demand following winter storms. Although the positive long term prospects for natural gas conflict with coal, coal is a fixture of the modern world. Coal should not be discounted for natural gas to this degree. Peabody and a select few coal players should recover nicely as demand is again realized.
While there is risk to the downside, the upside play to this space definitely tangible. The stock pays a dividend yield of 1.65% less than other good coal plays like Alliance Resource Partners (NASDAQ:ARLP) or National Resource Partners (NYSE:NRP) which pay 7.05% and 10.05% respectively, but there is far more potential for capital growth for Peabody, beyond the bounce I expect for April's earnings to $25.20, I see continued earnings growth for Peabody through 2013. I would beware of headline risk for this and other coal companies and I think that call spreads would be a superior strategy to owning the underlying security in the current environment, although owning this company is certainly a great play on coal's rebound as well as Peabody's leadership.
Peabody does not have the dividend that its sector does. I think Peabody's dividend strategy is appropriate, versus giving it away it is holding onto cash at this point and could be a brilliant leadership strategy as acquisitions may prove very useful or if there are short term declines in demand. Peabody invests in multiple types of coal, as well as invests heavily into clean coal operations, while a risk to Obama or EPA authority, clean coal presents a special competitive advantage with consumers as well as government entities.
April is a great time for this company to pop. While I do see some down days ahead like Friday, March 1st, I feel $25.20 is a reasonable call by April 15th, 2013. This is due to the company's unique strengths and investments that I expect will bear fruit during Q1 earnings on April 15th, 2013. I expect this stock will close higher both as we approach earnings and afterward when I am hoping for an earnings beat. Although there might be more pain in store for the overall market Monday, it should be short-lived as bears realize that Italy is more likely to solve their problems than not, regardless of who gets elected, since the ECB is not likely to allow that country to fail. Also that the sequester is not the catastrophic event it may have been made out to be.
I expect continued growth domestically with some concern at the all-time high level in the SPDR S&P ETF (NYSEARCA:SPY). As always, a wise investor must not look at a stock in a silo, but with my expectation that coal demand is secure, the coal industry as a whole should benefit from a reversal in investor sentiment both as revenues increase in 2013 and as legislation becomes more tolerant of clean coal. The SPDR Energy Sector ETF (NYSEARCA:XLE) would be a nice long play as it would benefit from increased earnings in the coal industry as well.