Peabody: Ideal Investment Option To Play Coal Market Rebound

| About: Peabody Energy (BTUUQ)

Peabody Energy (BTU) is the world's largest private sector coal company, with annual revenues in excess of $7 billion. The company has a diverse global portfolio, as the company has operations in the U.S. and Australia. The company has been making efforts to improve upon its cost structure and sell off its non-core assets to improve upon its bottom line results and strengthen its balance sheet in the prevailing soft coal market conditions. I believe BTU is the best coal stock in the prevalent tough coal market conditions, as the company has been successfully lowering its costs, reducing capital expenditure and selling non-core assets to preserve cash.

Financial Performance
Recently, the company reported a solid financial performance for 3Q2013. BTU reported an adjusted EPS of $0.05, beating consensus estimates of ($0.05). Along with solid earnings for the recent third quarter, the company also posted a healthy adjusted EBITDA of $312 million, up 23% quarter-over-quarter, beating consensus estimates of $240 million. Adjusted EBITDA of $312 million for the quarter also surpassed the company's EBITDA guidance range of $210-$270 million.

The solid bottom line result for the company in the recent third quarter was primarily driven by lower costs due to its cost improvement efforts. BTU was able to reduce its Australian operation costs by 8% year-on-year in the recent third quarter. Also, its costs for U.S. operations were at the lowest level in the last three years. BTU's total selling, general and administration (SG&A) for the recent third quarter dropped by $9 million quarter-on-quarter.

As coal market conditions remain soft, BTU continues to push hard on improving its cost structure and preserve cash to survive through the difficult times. The company further lowered its full year (2013) Australian costs guidance range to low-mid $70 per ton as compared to the prior guidance range of mid-$70 per tons. Also, the company is targeting to lower its U.S. operations costs by 2%-3% year-on-year to support its earnings.

The company's management expects an adjusted EPS of $0.27-$0.45 for the full year 2013, in comparison to consensus estimates of $0.30. Also, the company's EBITDA guidance range of $1.07-$1.15 billion for the year 2013 is ahead of consensus estimates of $1.10 billion. Other than cost control initiatives, the company has been reducing its capital spending to preserve cash. The company lowered its full capital spending guidance range by $50 million to $350-$400 million.

Stock Price Catalyst
Coal markets conditions are gradually improving due to better coal supply management and rising natural gas prices. The company's U.S. production for fiscal year 2013 is fully priced and committed. Moreover, approximately 75%-85% of the company's coal production for fiscal year 2014 is priced and committed, which provides greater clarity and visibility into future earnings.

The price and production volume contract for 2015 that is yet to be disclosed by the company, which I expect will be disclosed in the first half of 2014, could proved to be a important near term stock price catalyst.

Also, continuous cost reduction efforts will portent well for the stock price. The company's management indicated that there is more room for cost reduction in 2014. BTU expects that at the current Australian Dollar rate and constant sales sensitive costs, Australian operation costs can be sustained at $70 per ton. Also, a possible retract of the Australian carbon tax cost could have a positive impact of $1-$2 per ton on the earnings of the company in the future.

Moreover, met and thermal coal price recovery is expected to have a positive impact on the stock price as we move forward. Met coal price has recently shown signs of improvement, as met coal benchmark price for 4Q increased 5% year-on-year to $152 per ton. As coal companies will improve their coal supply management to address the concerns of oversupplied coal markets, we will see a recovery in coal prices. Recently, Arch Coal (ACI) lowered its met coal sales volume guidance for 2013 from 7.7-8.3 million tons to 6.9-7.3 million tons.

I believe coal market conditions will improve as we move forward. An expected rise in natural gas prices, better coal supply management and an economic recovery will portent well for the company and the coal industry. According to the Energy Information Administration [EIA], natural gas prices are expected to rise above $4 mmBtu, which I believe will result in higher coal-fired electricity generation and higher coal demand. The following graph shows expected rise in natural gas prices.
Click to enlarge

I believe the stock is a good investment option for long term investors to play a coal market rebound. The company has a strong asset base, with diverse geographical operations in the U.S. and Australia. Also, the company has a solid balance sheet in contrast to its peers; BTU has debt-to-equity of 130% in contrast to its peers' average of 200%. Furthermore, current valuations remain attractive, as the stock is currently trading at depressed valuations; Price/Sales of 0.75x and Price/Book Value of 1.2x. Due to the abovementioned factors, I reiterate my bullish stance on the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.