Risk-Reward Balanced at Peabody Energy - Analyst Blog

On March 24, we issued an updated research report on coal mining company Peabody Energy Inc. BTU.  Peabody is set to benefit from its presence in two of the fastest growing coal markets and its exposure in Australia. However, if the company fails to renew the existing long-term sales contracts on favorable terms it can impact its profitability going forward.

Peabody Energy, a Zacks Rank #3 (Hold) stock, reported broke even results in the fourth-quarter 2013. This compared favorably with the Zacks Consensus Estimate of a loss of 5 cents and the year-ago loss of $1.12 per share. The cost saving initiatives and higher productivity helped Peabody to lower unit costs by 3% for both the Midwest and Western regions of the U.S. In addition, higher productivity from its work force helped the company to offset the impact of lower realized prices.

The Asia-Pacific region is expected to drive global demand for coal for the next few decades. To capitalize on the surge in demand, Peabody is expanding its presence in Indonesia and Mongolia. In addition, in Dec 2013, the company entered into an agreement with China's Shenhua Group to create Sino-Pacific Coal Trading Corporation Pte. Ltd. These initiatives will help to strengthen its footprint in this region.

A well-coordinated transport system plays a vital role in the success of coal operators, as the coal producing mines are generally situated far away from the targeted market. Coal sales can significantly decline due to increases in transportation costs and the lack of sufficient rail and port capacity. Since these factors are beyond the control of Peabody, it could largely impact its sales volume.

Domestic consumption for coal is set to improve 4.6% year over year to 965.7 million short tons (MMst), as per a report from the U.S. Energy Information Administration.The projected increase in coal usage in the U.S. is attributable to higher demand for electricity and the rising cost of natural gas. Peabody's assets spread in the Powder River Basin and Illinois Basin will help it to capture a large part of the rising demand.

However, Peabody will have to ward off competition from other domestic coal producers like Alliance Resource Partners ARLP, Alpha Natural Resources, Inc. ANR, and Arch Coal, Inc. ACI.

As a caveat, increasing competition from natural gas and alternate power generation sources will continue to affect the demand for coal. In addition, stringent government regulations on granting permission to coal based power units could negatively impact the future prospects of coal miners like Peabody.