A Combined Glencore/Xstrata Should Buy Peabody Energy

by: Peter Epstein

There's been a lot of discussion about a combined Glencore, (OTCPK:GLCNF) and Xstrata, (OTC:XSRAY) -- Glenstrata -- potentially acquiring iron ore assets. And a recent article on SeekingAlpha did a good job at throwing copper companies such as Teck Resources, (TCK) into the mix. Another speculation involves Glenstrata acquiring Anglo American, (NASDAQ:AAL). However, that deal may be too large for Glenstrata to shoot for right away. Finally it's been suggested that Glenstrata acquire Walter Energy (NYSE:WLT).

A stronger case can be made for Glenstrata going after coal giant Peabody Energy, (BTU). Peabody is trading at an attractive valuation, has global operations and offers robust organic coking coal growth. While Peabody is not the only coking coal asset Glenstrata may look at, Peabody is a well-managed and powerful player. I could argue that Glenstrata should consider Alpha Natural Resouces, (ANR) and Arch Coal, (ACI), but for this article I focus on Peabody as the target.

Why Peabody above all others? It is one of the largest coal producers in the world. It has successfully diversified globally from from primarily a Western U.S. producer. Peabody has significant coal assets and organic growth opportunities in Australia, specifically in coking coal. In addition, Peabody has a presence in China, Indonesia and Mongolia.

Peabody also has a joint venture Carbones del Guasare, which owns and operates the Paso Diablo Mine in Venezuela. By far the most important thing for Glenstrata would be Peabody's exports to Asia from Australia and the huge potential of exports from the West Coast of the U.S.

Glencore is a global commodities trading powerhouse. Integrating Peabody's vast production of coking and thermal coal would be a winning trade. Peabody is not only a dominant coal producer, it's also a significant coal trader. Glencore could benefit from Peabody's coal trading experience and relationships and extract valuable synergies over time.

As mentioned earlier, Peabody is trading at an attractive valuation, with a P/E of about 7.7 times estimated 2013 earnings. And, Peabody's enterprise value of approximately $14 billion would be a good fit for Glenstrata. Peabody controls one of the largest coal resource bases in the world, approximately 9 billion tons. This figure does not include Macarthur Coal's coal resources in Australia. Peabody acquired Macarthur last year for close to $5 billion.

In the end, no one knows what Glenstrata will go after. It may be copper or iron ore or coal or other commodities. It may be a combination of commodities. Or, it may be a number of smaller acquisitions. For example, Glencore is in the midst of buying a fairly small South African thermal coal producer named Optimum Coal. What is known is that Glenstrata will be acquisitive; it's their stated goal. Peabody would offer a lot of bang for the buck: strong coking coal growth in highly sought-after regions.

Disclosure: I am long ACI, BTU, PCX, ANR, CNX.

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