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We are bullish on coal because of rising U.S. coal exports, the recent increase in natural gas prices, and lower coal-to-gas switch by power generators. Peabody Energy (BTU) is trading at cheap valuations compared to its competitors, and its rising sales volumes make us bullish on the stock.

BTU reported its third quarter results today, and the stock is up 10%. The company was able to beat earnings and revenue estimates. Adjusted diluted earnings per share for the quarter were $0.51 as compared to $0.90 in Q3 2011, beating earnings estimates by 50%. Revenues for the company were up 6%, to $2.1 billion, beating estimates of $1.97 billion. Better-than-expected performance is associated with high sales volume for the Australian Mining segment and strong U.S. segment margins.

Australian Mining revenues were up 20% and total sales volume was up 6%. Metallurgical coal, which is mainly used in steel production, experienced a significant increase in sales, from 1.6 million tons in Q3 2011 to 3.5 million tons in Q3 2012.

Operating costs and expenses were up as a percentage of sales from 70% in Q3 2011 to 73.5% in Q3 2012. Operating margins for the company fell to 13% in the recent third quarter as compared to 19% in Q3 2011. Adjusted EBITDA for the quarter was down by 9% to $460 million.

Inventory level for the company has been rising; inventory as of Sept. 30, 2012, amounted to $554 million as compared to $444 million in December 2011. To overcome the problem of rising inventory, the company is planning to cut its production, as coal demand has been on the slower side recently. The company is focusing on cost control initiatives and capital discipline, which will benefit the company over the next year. The company specified $100 million of savings to be achieved, mainly by workforce reductions and lower outside service spending.

Guidance

The company is expecting full-year 2012 adjusted earnings per share in the range of $2.10 to $2.30, vs. analyst expectations of $1.79. It also increased its full-year 2012 sales forecast, and now it expects a sales volume of 240-250 million tons.

Last week, the company announced a regular quarterly dividend of $0.085 per share, offering a dividend yield of almost 1.15%. The company has an operating cash flow yield of almost 20% and a free cash flow yield of 2.9%.

The table below shows that the company offers better margins as compared to its competitors. In addition, it has cheaper valuations as compared to its competitors based on its forward P/E of 9.5 times.

BTU

CNX

Arch Coal Inc. (ACI)

Alpha Natural Resources, Inc. (ANR)

Forward P/E (2014 earnings)

9.5 x

14 x

NA

NA

Gross Margin

29 %

32 %

20 %

15 %

Profit Margin

11 %

11 %

-8 %

-37 %

Operating Margin

18 %

12 %

7.25 %

2.2 %

Debt to Equity

108 %

82 %

146 %

60 %

ROE

16.5 %

17 %

-11%

-43 %

Source: Yahoo Finance and Nasdaq.com.

Peabody Energy and other coal companies in the U.S. are expected to benefit from the expected rise in coal demand. U.S. coal exports have been reaching record highs this year, as more coal is demanded by power generators in Europe. Coal exports to Europe increased by almost 30% in the first quarter of 2012. However, demand for coal in the U.S. is also expected to increase, as natural gas prices are rising and will continue to rise in the near future. The price of natural gas increased from less than $2, back in April, to $3.3 as of now. Rising coal demand will lead to coal price increases, which is at a low level since the shale gas boom. The price of coal is down 20% in the first half of the current year. Coal to gas switching is already slowing down as natural gas prices are increasing and natural gas is losing its competitive edge.

Sales volume growth, coupled with an increase in coal prices, will help the company expand its top and bottom lines. BTU also has a strong balance sheet and is in a better position to take advantage of the increase in coal prices. BTU is also cheaper than its competitors. It offers a dividend yield of 1.2%.

Source: Buy Peabody Energy To Play The Rebound In The Coal Industry