Peabody Energy (BTU) is holding its analyst day in New York City. Analysts will be regaled with a new 110 page power point presentation about coal's "Super Cycle." SA's Mark Anthony will love this presentation! Peabody has been consistent in saying that China, (and increasingly India) are leading the way to a bright future in coal. While the near-term remains uncertain, Asia's urbanization is a force that can't be stopped. Peabody CEO Greg Boyce is hosting a coal love fest, free and unlimited cool-aid for all.
Going through the presentation, Peabody believes that coking / "MET" coal is in structural short supply. To be clear, Peabody is referring to premium hard coking coal and PCI, not ALL coking coals. We've seen that pricing for mediocre Hi-vol and semi-soft grades has come off considerably more than that of Australia's Bowen basin benchmark grade. Australia is the primary source of the top quality coking coals in the world. Teck Resources, (TCK) and Walter Energy, (WLT) also have very significant amounts of premium hard coking coals.
Boyce is saying that U.S. coal fundamentals are "showing signs of recovery." This is a bullish view; he could have said he's seeing signs of stabilization. Peabody walks the walk: They bought back $200 million of their corporate bonds and $100 million of common stock in the second quarter. Presumably, if Peabody wasn't buying shares this quarter, the stock would be below $20.
In support of the thesis of a U.S. coal recovery the presentation states that coal use will likely be down 100-120 million tons in 2012, but use will rebound next year as gas prices rise. As I write this, spot natural gas prices are at $2.87 per mcf, up about $1 or ~50% from recent lows. Natural gas prices above $2.75 are widely thought to be a level in which coal-to-gas switching reverses in the Power River Basin, "PRB". (Note: the price at which coal-to-gas switching occurs in other U.S. coal basins is higher than $2.75, perhaps $4.25 per mcf in central Appalachia.)
Further commentary includes the view that PRB and Illinois basin coal will continue to take market share from central Appalachia, "CAPP" and that coal exports are growing from the west coast and the Gulf and that coal plant retirements are likely to be less than feared. However, the magnitude of export increases may not move the needle on PRB coal prices anytime soon. Peabody states that export capacity could increase by 100 million tons in the next 5 years based on announced initiatives. But how much of that 100 million tons will actually materialize, and how much will be off the west coast?
Given that I'm reviewing a 110 page propaganda piece, I will not be able to touch upon all of the points made. Boyce has some good new slides demonstrating that Asian growth will continue to be a driving force. For example one of the slides contends that an incremental 1.2 billion metric tonnes of coking coal will be needed to lift China, India and Brazil to a "stable stage steel intensity."
Finally, Peabody is not shy in suggesting that its stock is significantly undervalued, which is probably true, (but so are a few others). The presentation has many graphs and comparisons with peer U.S. coal producers. For example, Peabody's gross margin is 31% vs. peer gross margins of 21%. Peabody enjoys a higher gross margin due to the fact that 50% of its earnings are now coming from Australia, with a large portion of Australia's earnings coming from premium hard coking coal and PCI.
Please note, my comments about a love fest and cool-aid and propaganda are clearly meant to be tongue-in-cheek. The slide presentation is actually very well done, very comprehensive and offers a compelling bull case for a Super Cycle in coal. I believe a more realistic view of the market is that yes, coal prices will likely rebound, but when and by how much? Global costs are rising even in the face of weak demand and pricing. China is a known unknown. At times they're importing copious amounts of coal, other times they step back from the seaborne markets for months. Volatility will be with us for the foreseeable future.
Peabody is a perfectly good and relatively safe way to play the coal sector if one wants exposure. I'm on record as being favorably inclined towards Alpha Natural Resources, (ANR), Walter, Consol Energy, (CNX) and MLPs Natural Resource Partners, (NRP) and Alliance Resource Partners, (ARLP) after this year's massive sell-off.(Please see my recent articles on ARLP and NRP.)