Shares of Peabody Energy (BTU, Financial) continue to sink under the pressure of falling coal prices, which seems to be far from a turnaround in the near future. On the contrary a host of negative cues are coming in from the market with analysts estimating further decline in coal demand; fueled by falling crude prices coupled with strict environmental regulations from government agencies. Led by these headwinds its stocks have more than halved in the past year and are currently trading near all-time lows. But this decline in stock prices could be a blessing in disguise for new entrants as the valuations of the company look cheap and may reward them handsomely over the period.
A look at the market situation
The company deals in both metallurgical as well as thermal coal, and we shall discuss each of their prospects in detail. The management anticipates that the demand for seaborne metallurgical coal in 2015 is expected to outpace supply increases for the first time since 2011. These higher expectations stem from the rise in global steel production coupled with the growth in Australian metallurgical coal export. Additionally there are positive cues from the Asian giants such as India and China. In 2014, Indian imports grew around 20%, and the momentum is expected to continue further as the economy grows and infrastructure continues to be buildout.
China on the other hand may see some minor glitches in its demand during the current fiscal. But its long-term prospects look promising, and greater quantity of high quality coal will be required on account of rationalization of its domestic production. Moreover investments in metallurgical coal projects have all been dried up in the past two years and new projects can take years to bring online. This will reduce production, while the gradual increase in demand as we discussed above will prove profitable for the industry in the coming years.
Moving onto thermal coal; again the Asian giants stand out and the company will look up to them to drive its growth. China’s electricity demand increased 4% in 2014 but in contrast coal imports declined on account of higher capacity generation from hydropower. But Peabody anticipates rising coal-powered electricity generation in 2015 while hydro growth will slow significantly. On the other hand, in India, coal-powered generation rose 13% in 2014. This led to a significant surge in coal imports, which got a further lift as its domestic production proved inefficient. Going forward, coal import momentum is expected to remain strong in the country even as the government is working hard to meet the needs of millions of Indian people suffering with inadequate power.
Headwinds to watch
Unfortunately most of the growth story ends here and the rest of the world possesses a gloomy picture. But two years from here, the company projects that coal will satisfy around 40% of U.S electricity requirements.
Although declining natural gas prices are matters of concern for the coal mining industry, Peabody is counting on its Powder River Basin (PRB) coal, which is expected to remain competitive with natural gas. This could consequently boost PRB consumption up to 20 million tons this year. According to the management’s forecasts, PRB and Illinois Basin demand could grow up to 50 million to 70 million tons during this time, which is a good sign.
In addition, Peabody has implemented various cost reduction initiatives, and achieved significant ground in this direction. Over the past two years, its aggressive efforts have generated over $500 million in savings. Along with this, in 2014, Peabody achieved the lowest U.S. and Australian operating cost per ton since 2010. Considering the present pricing environment, the company’s initiative to focus on its low cost assets coupled with its cost cutting initiatives is a tangible step in improving its fundamentals, which will yield promising results in the days to come.
Conclusion
Although its near-term market is quite disappointing but considering its lower valuations Peabody at this point is quite appealing. The company has a P/S and P/B ratio of 0.22 and 0.53 respectively, which is quite good compared to its peers. Moreover, the stock has declined near to its all time low values. Therefore considering these factors at present valuations Peabody could be a good long term bet given the fact that coal prices rise from its present slump.
