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Summary

  • Coal has been ugly and sentiment is poor.
  • Hard to find stocks at steep discounts to perceived intrinsic value.
  • We think Peabody is a steep discount to intrinsic value.

This recent post on Seeking Alpha caught my eye as it could explain the recent weakness in the coal sector as well as Peabody Energy (NYSE:BTU).

The Obama Administration has made coal the enemy the last few years, and it has shown up in the stock prices, although the slowdown in China certainly didn't help either.

With a lot of the stock market looking pretty fairly-valued, or at least not nearly as cheaply-valued as we saw in 2011 and 2012, we started looking at coal in late 2013, and started buying BTU in Q1 '14.

Peabody Energy reported a tough quarter in Q1 '14, missing on both EPS and EBITDA, although Peabody noted in the conference call notes that it saw "substantial demand increase" in Q1 '14, probably due to the brutal Midwest and East Coast winters and the drawdown in coal inventories.

Two items caught our eye with BTU: as of Q1 '14, the coal producer still has a 7% free-cash-flow yield, and remains free-cash-flow positive on a 4-quarter trailing basis.

Morningstar has an intrinsic value rating on BTU of $26, which is a 38%-40% discount to its perceived intrinsic value at today's price of $16.15

BTU was down 6% this week, the last week of May '14 and down 13.5% in the month of May.

The headlines are still rough. China seems to be rotating between slower and somewhat stable and the headline data is probably phony anyway. In Q1 '14, China imports of coal rose 5% per the BTU conference call.

We normally like to give readers more fundamental detail when writing about a company, but our spreadsheet on BTU is pretty new.

Consensus analyst expectations per Thomson Reuters are for earnings and revenue growth in 2014 and 2015 presently, so if readers can be a little patient (you get a 2% dividend yield on BTU), then we are betting for clients we get a payoff on BTU late 2014, early 2015.

The sector has been ravaged for sure: we are long BTU and the coal ETF (NYSEARCA:KOL) in client accounts, with about a 1.5%-2% total position.

(Because of the operating losses, our internal valuation model, which uses forward earnings growth, and forward earnings estimates, isn't much help, thus we defer to the Morningstar valuation model. )

The basic materials names are lapping very easy comps off Q2 '13 and late 2013. The sector usually outperforms starting in late summer and calendar 4th quarter every year.

Source: Peabody Energy Trading At 35%-40% Discount To Perceived Intrinsic Value