Downward Revisions At Arch Coal, Peabody Won't Deter Growth

Feb. 3.12 | About: Arch Coal (ACIIQ)

For investors looking to benefit from a recovery and a shift back into the industrial economy, coal producers offer an ideal way to back such an outlook. Currently, Arch Coal (ACI) is rated a "buy" on the Street while Peabody (BTU) is rated near a "strong buy." The two have recently been revised downwards following signs of greater macro uncertainty. Consensus estimates for EPS fell for a net change of -2.8% at Arch Coal versus -33.4% at Peabody.

From a multiples perspective, Peabody is significantly the cheaper of the two. It trades at a respective 9.9x and 7.8x past and forward earnings with a dividend yield of 0.9%. Arch Coal, on the other hand, trades at a respective 19.6x and 7.9x past and forward earnings.

At the third quarter earnings call, Peabody's CEO, Greg Boyce, noted improving developments:

Now in a time when one can receive mixed signals from the equity and asset markets, I'm pleased to report that our business is not only sound but set for significant growth with our organic platform and the successful acquisition of Macarthur Coal. Peabody's on track for record revenues and EBITDA this year. Demand and pricing for our products is favorable, our pipeline of projects is strong and for every caution light we see in macroeconomic data, there are multiple favorable signals at the coal market level.

So if you consider these following data points in the global markets, global GDP is still expected to come in at more than 3% growth in 2011. Global scale production is up 9% year-to-date, and projections continue to call for more than 5% growth in steel production for 2012, equaling a rise of 50 million tons of met coal use just next year.

Fourth quarter results were nevertheless dismal for the firm. EPS of $0.98 was significantly below expectations. With that said, ROIC is set to take off after 2012 and expand by 300 bps until 2014. In the next year alone, the Macarthur integration will yield $80M worth of synergies.

Consensus estimates for Peabody's EPS forecast that it will decline by 12% to $3.31 in 2012 and then grow by 43.5% and 3.4% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $4.71, the stock has 51.2% upside.

Arch Coal recently signs long-term coal throughput contract with Kinder Morgan wherein the former will help expand the latter's $140M investments in export facilities. Despite longwall outages in Mount Laurel, the company still has impressive capacity. And the expansion into Appalachia with cheap longwall mines at Tygart Valley will only further diversify met coal supply. Beckley and Sentinel continue to impress as the company focuses on expanding scale.

Consensus estimates for Arch Coal's EPS forecast that it will grow by 2.6% to $1.17 in 2011 and then by 68.4% and 22.4% in the following two years. Assuming a multiple of 9.5x and a conservative 2012 EPS of $1.93, the rough intrinsic value of the stock is $21.96.

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