Investors Souring on Peabody are Forgetting Something

Peabody Energy BTU plummeted over 5% in early morning trading as its earnings results disappoint on lower-than-expected earnings. Higher coal prices helped revenues to jump 18% to a new record: $7.97 billion, but the fall in overall earnings is alerting investors to the mining company's potential downside. The company announced Tuesday morning that its EPS was 98 cents on an operating EPS of $1.11, far below analyst expectations of $1.33 per share. The results were partly the result of falling yields on Australian operations. EBITDA for the company's Australian operations was only $338.1 million, down as much as 24.8% from some analyst estimates. Australian operations account for 10% of Peabody's total production, which both exposes Peabody to foreign currency and makes it vulnerable to slowing output from down under. The move has prompted analysts to cut their price targets on the company, with Deutsche Bank droping their target to $50 with a buy rating. Citigroup is slightly more optimistic, with a $55 target on the company. Both figures are still considerably higher than the stock's current price of $35.45. The company's heavy investment in coal mining in the United States and Australia has exposed it to the whims of coal demand. With American coal demands falling, the company is hoping that Chinese demand will pick up the slack. We've been here before. When TransCanada TRP recently lost its Keystone XL pipeline at least for now, Canadian Prime Minister Stephen Harper pointed to China as a greater source of energy demand for the country, who deends for energy consumption as an economic engine as the world's 5th largest energy producer. Australia is also betting on China, as the country exports over 25 million tons of coal to the Asian giant. The country is betting on rising coal exports to China as the country's industrial base continues to grow (albeit at a slower pace) and domestic coal production in China becomes more expensive. Demand for Australian coal has risen steadily thanks in part to the country's subsidies on fossil fuels production, the relative stability of the Australian dollar and Australian economy, and the country's reliable mining infrastructure. However, a jump in Chinese coal demand is a long-term possibility that needs to be weighed against several factors. How long can energy companies use China as an ATM machine--especially if China is facing a housing market crash alongside incessent social unrest that sometimes verges on the ridiculous. Australian activity is just a tenth of Peabody, however, so investors cannot ignore the company's American production, which will have a much bigger affect on the company's value in the near term. American mining was a good surprise for this earnings season, with EBITDA from American mining above analyst estimates at $346.8 million and revenue for American operations slightly above estimates at $1.17 billion for the quarter. This is much higher than Australian revenue of $772.6 million, and a 5% rise in U.S. shipments means that investors are overlooking the company's American growth--an unsurprising inevitability, as China remains a much sexier topic than a record output of the company's North Antelope Rochelle Mine in Michigan. The company was also helped by increased coal prices, but Peabody cannot depend on rising prices forever, as cheap natural gas has challenged the rising price of coal. While the possibility of rising oil prices might make coal more appealing, investors must also remember that rising oil production might also challenge coal's appeal.

ACTION ITEMS:

Bullish: Traders who believe that Peabody will reach analysts' price target might want to consider the following trades:

  • Buy BTU while it's cheap. The 5% drop in the stock price is a market reaction to bad news that may not last if the company's American output and coal price points continue to rise.
  • For a more diversified approach, consider the Market Vectors Coal ETF KOL or Powershares Global Coal PKOL. These are particularly appealing if you believe widespread or global demand for coal will increase beyond Peabody's output capabilities.

Bearish: Traders who think that coal's days are numbered may want to think about some alternatives:

  • Short BTU.
  • If you think Peabody's regional position makes it weaker but coal demand will not go away, you might consider buying some alternative coal companies, such as Patriot Coal PCX and Arch Coal ACI.
  • If you think coal's days are numbered and alternatives will shine, solar companies such as First Solar FSLR, Sunpower SPWR, and Suntech STP are strong players in the solar sector, although volatility and uncertainty have hit the sector recently. Alternatively, natural gas companies like Chesapeak CHK and EOG Resources EOG may be poised to benefit from moves away from coal.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.
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