I’m no expert in macro-economic cycles. I’m not an expert in economic drivers of energy prices. I’m certainly not an expert in coal. I have no experience in coal mining. I don’t typically invest in cyclical commodities companies. My initial interest in Peabody (BTU, Financial) was sparked because it’s in an out of favor sector and appears to be very cheap. The price appears to be so low, on various metrics, that I believe the company is worth a closer look.
Company History and Business
As I alluded above, BTU is primarily in the business of mining for coal. From Yahoo Finance: “Peabody Energy Corporation engages in the mining of coal. It mines, prepares, and sells thermal coal to electric utilities and metallurgical coal to industrial customers. The company owns interests in 30 coal mining operations located in the United States and Australia, as well as owns joint venture interest in a Venezuela mine. It is also involved in marketing, brokering, and trading coal. In addition, the company develops a mine-mouth coal-fueled generating plant; and Btu Conversion projects that are designed to convert coal to natural gas or transportation fuels; and clean coal technologies. As of December 31, 2011, it had 9 billion tons of proven and probable coal reserves. The company was founded in 1883 and is headquartered in St. Louis, Missouri.”
Valuation
“If you need to use a computer or calculator to make the calculation, you shouldn’t buy it.” -- Warren Buffett[1]
This is what makes this sector, and BTU in particular, so interesting. The company is currently trading at just above its 52-week low of $22.18 [2] (down from a 52-week high of $61.85). It’s price-to-earnings ratio stands at 6.44, with a forward PEG below 1. The price-to-book value of the company sits at just above 1.
Using the Discounted-Cash-Flow calculator on Gurufocus (which they point out is actually a Discounted-Earnings-Calculator), which assumes a 20% growth rate annually for 10-years, the calculator assumes an approximate fair value of $113 and a Margin of Safety of 80%. Even if we alter that growth assumption input to a much more conservative 5%, the estimated fair value is $42, nearly twice the current price.
Especially interesting about large cyclical commodities players, is their ability to decrease production of commodities when prices wane. BTU has been decreasing coal production. April shipments were approximately 150 million tons lower than 2011 shipments--representing the lowest monthly shipments in over 15 years.
Meanwhile, the International Energy Agency expects demand for coal to increase by 65% by 2035, larger demand growth than that of oil, natural gas, nuclear or hydro (this increased demand provides the most obvious catalyst for BTU stock). [3]
BTU has a proven track record of growth, growing operating cash flow more than 250% over the last 5 years. BTU also represents a “best of breed” sort of opportunity, producing superior margins in comparison to their competitors...while simultaneously offering a cheaper share price.
Risks
“The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.” -- Seth Klarman
Every commodities company is a slave to macro-economic factors. The company is extremely cyclical. Oil, natural gas and alternative energy prices create risks related to the demand for coal. The cyclicality of this business creates increased risks as well--but of course if you’re going to invest in something this cyclical…you want to invest during a down cycle.
Regulatory factors present risks as well. Energy companies are exposed to high levels of regulatory risks that affect their businesses. Coal has risks due to environmental regulatory factors as well.
Finally, energy companies maintain an extremely complex web of hedges. The aim of these hedges is to level out some of the cyclicality and to provide some earnings stability, but obviously not every hedge works as it is contemplated. Black swan events happen…especially when you’re trying to predict commodity prices.
Conclusion
BTU is cheap based on pretty much any metric you can think of. An upward move in demand for coal should correlate to stronger market conditions for this very cyclical company. While you wait, you can collect an attractive 1.5% dividend. I think the low stock price curbs a great deal of the downside risk. While BTU is unlikely to be a homerun type pick (4x or higher), it provides a compelling and significant margin of safety that should make it very attractive to value investors with longer time horizons (the core advantage of the individual investor over the institutional investor). Feedback and criticism is welcome…I’d actually love to hear some thoughts from an analyst that works in this space.
Disclosure: Long BTU
About the author: Todd Metheny is an attorney, entrepreneur and value investor living in St. Louis, Missouri. He is one of the founders of Passerby, a crowdfunding platform exclusive to film--and focused on offering equity investment opportunities in films by sometime in 2013 (currently offering a donation platform). Besides an interest in all things investing, he is also an avid fan of film, the St. Louis Cardinals, the St. Louis Rams, technology, law, web development/programming and folk rock. Follow him on twitter for a random mish-mash of the above: @toddmetheny. If you know filmmakers, send them to http://passer.by.
[1] I’ve also seen this quote as “to determine something is cheap”…this version of the quote can be found at http://blogs.wsj.com/marketbeat/2009/05/02/buffett-and-munger-stay-away-from-complex-math-theories/
[2] BTU closed on Friday, June 22, 2012 at $22.58.
[3][ Stats from a May 2012 BTU investor relations presentation.
Company History and Business
As I alluded above, BTU is primarily in the business of mining for coal. From Yahoo Finance: “Peabody Energy Corporation engages in the mining of coal. It mines, prepares, and sells thermal coal to electric utilities and metallurgical coal to industrial customers. The company owns interests in 30 coal mining operations located in the United States and Australia, as well as owns joint venture interest in a Venezuela mine. It is also involved in marketing, brokering, and trading coal. In addition, the company develops a mine-mouth coal-fueled generating plant; and Btu Conversion projects that are designed to convert coal to natural gas or transportation fuels; and clean coal technologies. As of December 31, 2011, it had 9 billion tons of proven and probable coal reserves. The company was founded in 1883 and is headquartered in St. Louis, Missouri.”
Valuation
“If you need to use a computer or calculator to make the calculation, you shouldn’t buy it.” -- Warren Buffett[1]
This is what makes this sector, and BTU in particular, so interesting. The company is currently trading at just above its 52-week low of $22.18 [2] (down from a 52-week high of $61.85). It’s price-to-earnings ratio stands at 6.44, with a forward PEG below 1. The price-to-book value of the company sits at just above 1.
Using the Discounted-Cash-Flow calculator on Gurufocus (which they point out is actually a Discounted-Earnings-Calculator), which assumes a 20% growth rate annually for 10-years, the calculator assumes an approximate fair value of $113 and a Margin of Safety of 80%. Even if we alter that growth assumption input to a much more conservative 5%, the estimated fair value is $42, nearly twice the current price.
Especially interesting about large cyclical commodities players, is their ability to decrease production of commodities when prices wane. BTU has been decreasing coal production. April shipments were approximately 150 million tons lower than 2011 shipments--representing the lowest monthly shipments in over 15 years.
Meanwhile, the International Energy Agency expects demand for coal to increase by 65% by 2035, larger demand growth than that of oil, natural gas, nuclear or hydro (this increased demand provides the most obvious catalyst for BTU stock). [3]
BTU has a proven track record of growth, growing operating cash flow more than 250% over the last 5 years. BTU also represents a “best of breed” sort of opportunity, producing superior margins in comparison to their competitors...while simultaneously offering a cheaper share price.
Risks
“The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.” -- Seth Klarman
Every commodities company is a slave to macro-economic factors. The company is extremely cyclical. Oil, natural gas and alternative energy prices create risks related to the demand for coal. The cyclicality of this business creates increased risks as well--but of course if you’re going to invest in something this cyclical…you want to invest during a down cycle.
Regulatory factors present risks as well. Energy companies are exposed to high levels of regulatory risks that affect their businesses. Coal has risks due to environmental regulatory factors as well.
Finally, energy companies maintain an extremely complex web of hedges. The aim of these hedges is to level out some of the cyclicality and to provide some earnings stability, but obviously not every hedge works as it is contemplated. Black swan events happen…especially when you’re trying to predict commodity prices.
Conclusion
BTU is cheap based on pretty much any metric you can think of. An upward move in demand for coal should correlate to stronger market conditions for this very cyclical company. While you wait, you can collect an attractive 1.5% dividend. I think the low stock price curbs a great deal of the downside risk. While BTU is unlikely to be a homerun type pick (4x or higher), it provides a compelling and significant margin of safety that should make it very attractive to value investors with longer time horizons (the core advantage of the individual investor over the institutional investor). Feedback and criticism is welcome…I’d actually love to hear some thoughts from an analyst that works in this space.
Disclosure: Long BTU
About the author: Todd Metheny is an attorney, entrepreneur and value investor living in St. Louis, Missouri. He is one of the founders of Passerby, a crowdfunding platform exclusive to film--and focused on offering equity investment opportunities in films by sometime in 2013 (currently offering a donation platform). Besides an interest in all things investing, he is also an avid fan of film, the St. Louis Cardinals, the St. Louis Rams, technology, law, web development/programming and folk rock. Follow him on twitter for a random mish-mash of the above: @toddmetheny. If you know filmmakers, send them to http://passer.by.
[1] I’ve also seen this quote as “to determine something is cheap”…this version of the quote can be found at http://blogs.wsj.com/marketbeat/2009/05/02/buffett-and-munger-stay-away-from-complex-math-theories/
[2] BTU closed on Friday, June 22, 2012 at $22.58.
[3][ Stats from a May 2012 BTU investor relations presentation.
