Why Peabody Energy Is A Good Investment

Nov. 3.11 | About: Peabody Energy (BTUUQ)

Peabody Energy Corporation (BTU) is a company that deals in the exploration, mining and production of coal. It is the world’s largest private sector coal company. Coal has been hit hard lately, but that doesn’t mean it might not be worth a risk, especially this time of year. In fact, Paramount Options president Raymond Carbone recently told CNBC :

The best way to winterize a stock portfolio is to buy shares of coal or oil companies rather than buying the commodities directly.

Peabody underperformed analyst estimates when it announced its third quarter earnings, both in terms of earnings per share and quarterly revenue according to Zacks. BTU is still well-positioned, but analysts are still rating the stock as a hold. Hedge funds like Jeffrey Vinik’s Vinik Asset Management and Wayne Cooperman’s Cobalt Capital Management are bullish on the company, or at least they were at the end of June. Both men increased their funds holdings in BTU in the second quarter, but is it a good buy now?

Not everyone is a pro when it comes to company valuation, but there are a few metrics anyone can use to get an approximation of a stock’s real value:

✓ The current price multiples

✓ The consistency of past earnings and cash flow

✓ The amount of growth expected

Let’s see what these numbers can tell us about BTU.

Current Price Multiples

First, we will look at the P/E ratio. This metric divides a company’s share price by its earnings per share – the lower the number, the better. P/E ratio indicates how many times its earnings a company is trading at. If the P/E ratio is high, the stock could be overpriced.

Next, we will take a look at the company’s enterprise value to unlevered free cash flow. To get this metric, we will divide the company’s enterprise value (market cap plus debt minus cash) by its unlevered free cash flow (just free cash flow with interest payments added back in). The lower this number, the better. Like with the P/E ratio, if this number is too high it means the stock is likely overpriced.

There are two different camps of thought on this subject, each thinks the other multiple is more important, but they agree on one common aspect. The lower these multiples are the better.

To get some perspective on these numbers, let’s look at BTU’s P/E ratio and EV/FCF, as well as that of its nearest competitors – Consol Energy (NYSE:CNX), Arch Coal (ACI) and Alpha Natural Resources (ANR). At just 11.57, BTU has the lowest P/E ratio of the competitors we considered. ANR has the next lowest at 14.36 P/E ratio, while CNX and ACI are roughly tied, coming in at 17.20 and 17.63 respectively. With regard to EV/FCF, ANR was by far the lowest at 6.83. CNX was next at 13.72, followed by ACI at 15.83 and finally BTU at 25.27.

Earnings Consistency

An ideal investment has strong consistency in its earnings. It would have a small range for its free cash flow yield. Over the last five years, BTU’s free cash flow yield has ranged from -1.83% to 17.77% and averages 5.36%. As of November 1, its most recent free cash flow yield is 4.77%. CNX has a much narrower range, ranging from -1.75% to 11.77%, but it has a much lower average at 1.73%. Its most recent free cash flow yield is 9.98%. ACI has one of the broader ranges we looked at, going from -7.37% to 14.09%, its most recent FCF yield. ACI averaged a free cash flow yield of 3.22% over the last five years. ANR has the highest average we looked at, coming in at 11.11%, with a range of 2.46% to 29.52%. Now that we know where these stocks have been, let’s take a look at their expected growth.

Expected Growth

Expected growth estimates can be wrong. In fact, they are frequently overstated, but they can be useful when comparing companies or comparing a company’s performance relative to its industry. In the case of BTU, the company’s earnings grew by 14.8% over the last five years, outpacing the industry, which grew by just 10.2%. Unfortunately, growth estimates for BTU aren’t available. However we can assume that it will be similar to industry’s growth estimates which is 10.3%. We also don’t have growth estimates for CNX, but we know that it grew just 0.9% over the last five years.

The Bottom Line

We like BTU the best. BTU has a good balance. It offers a low P/E ratio and strong FCF yield, and while its earnings were disappointing, the downward momentum could mean it is a good time to buy. Point in fact, Cramer recommended this stock at $35.77 a share but recommended hold at $38.66. It is currently trading just under $40. We recommend holding off on buying until the share price comes down to $37, in order to allow plenty of room for upside. Until then, consider stocks like Sara Lee (SLE) or Chevron (NYSE:CVX). SLE has a 2.50% dividend and is trading at just 8.38 times its earnings. Chevron has a PE ratio of 7.8 and yields 3.1%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.