I am bullish on Peabody Energy (BTU) as it has a higher gross margin of 24% in the industry compared to its peers. BTU also delivered better than expected results for Q1 2013 and has a cheap forward P/E of 12.7x as compared to the S&P forward P/E of 15x. Moreover, according to the Energy Information Administration (EIA), coal-fired electricity generation and coal consumption in the U.S. are likely to increase in the coming years and will most likely result in the U.S. coal market rebound.
Recent trend in the industry
The last 18 to 24 months had been tough for the U.S. coal industry. The coal industry faced intense pressures due to rising regulations and a drop in natural gas prices in recent years. Due to lower natural gas prices, gas fired electricity generation increased, whereas coal share in electricity generation dropped from 42% in 2011 to 37% in 2012.
The majority of coal stocks lost significant proportion of their market capitalization in the recent past as natural gas became a more competitive energy source as compared to coal. The following table shows the performance of the coal ETF (KOL) and three other coal stocks, including BTU, since the start of 2013.
Alpha Natural Resources (ANR)
Arch Coal (ACI)
Source: Google Finance
However, coal markets are expected to rebound as EIA forecast expects coal-fired electricity generation to increase by approximately 3% in 2013 as compared to 2012, which will lead to higher demand for thermal coal. Also, infrastructure development in China and India is likely to drive up demand for met coal; which is used in steel production.
BTU registered an earnings beat of 9 cents, by posting adjusted EPS loss of $0.05 as compared to analysts' consensus of $0.15. Adjusted EBITDA of $280 million for the recent first quarter was also above the consensus of $235 million. The adjusted earnings and EBITDA beats were mainly driven by higher than expected realized pricing in the U.S. and an improved cost structure for the company's Australian operations.
Reported revenue for the recent first quarter came out to be $1.75 billion, as compared to $2 billion in the corresponding period last year. The U.S. mining operations had the highest contribution to total revenue of 55% closely followed by 42% by the Australian mining operations in the recent first quarter. BTU sold 57.2 million tons of coal in the first quarter of 2013, down 4.5% year on year basis.
BTU issued an earnings per share guidance range of $0.25- $0.01, as compared to analysts' consensus of $0.01 per share. The company also gave adjusted EBITDA guidance range of $240 - $300 million. In 2013, BTU expects total coal sales in range of 230 - 250 million tons.
Given the feeble coal demand, the company has been working to improve its cost structure. The improvement in the cost structure was evident in Australian operations last quarter, and is also what lead to earnings beat in the recent quarter. The U.S. mining costs are also projected to be 2% - 3% lower on a year on year basis for 2013. This cost reduction projections for the U.S. operations will result in cost savings of 30 cents to 50 cents a ton, as compared to last year.
As natural gas prices have bottomed out and started to rise as compared to 2012 average price level, this will make coal costs competitive in comparison to natural gas and hence coal-fired electricity generation will increase. This will bode well for U.S. coal stocks. Also, EIA has projected the U.S. coal consumption will increase by 7.3% in 2013 and 9.11% in 2014, as compared to coal consumption of 889 MMst in 2012. Furthermore, 450 gigawatts of new coal-fired generation is expected to be added in the system in the next five years. The aforementioned factors are likely to result in a rebound in the coal markets and attractive potential returns for coal investors.
I believe BTU is excellently positioned to take advantage of an expected rebound in the coal markets. The company has higher gross margins of 24% as compared to its peers' (ACI and ANR) of 17% each. Moreover, BTU's ongoing cost reduction efforts will help the company to support its depressed bottom line. Therefore, I am bullish on the stock.