China And India Fire Up Peabody Coal Profits

By Greg Sushinsky | October 25, 2010 AAA

Peabody Energy Corp. (NYSE:BTU) produced a strong third quarter led by large sales increases in China and India. Profits more than doubled while revenue shot up 11%. The company raised its earnings outlook for the year, although the market sent the stock down slightly on concerns that China's coal demand could lessen due to China's interest rate hikes.

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An Asian Story
While Peabody is the world's largest private sector coal producer and is based in the U.S., its story is increasingly becoming a global one. This quarter, the Asian coal demand was able to more than make up for the less vigorous demand in the U.S. and Europe. Revenue for the quarter was $1.86 billion, up from $1.67 billion in the year ago quarter. Net income rose to $236.3 million, or 83 cents a share - 99 cents excluding charges - compared to $110.8 million or 40 cents a share last year's quarter. Demand for coal in the Pacific region is running 15% higher than last year at this time.

Coal Burning Bright
These are good times for coal companies. Though it has been maligned as "dirty" energy, coal continues to prove its utility throughout the world. Not only Peabody, but other coal producers such as Arch Coal (NYSE:ACI) are finding flush times. Arch Coal bought Jacobs Ranch from Rio Tinto (NYSE:RTP) this year, which should lower costs. Arch still has relatively high debt so the Jacobs Ranch purchase assumes even greater importance for Arch as it closely monitors its spending.

James River Coal Co. (Nasdaq:JRCC), a smaller coal producer, is a stock trading at a lower valuation, but the company is positioned to produce better earnings than the market expects. As a smaller producer, however, James River doesn't generate the massive cash flows that Peabody or Arch can, so again, watch the debt levels.

Appalachian coal producer Alpha Natural Resources (NYSE:ANR) bought Foundation Coal a year ago, which gives Alpha more scale. Alpha also took additional debt onto its balance sheet in the deal.

Peabody's Future
For the near term, meaning the rest of this year, Peabody should continue to reap the benefits of the increased demand in China and India. Coal imports in China have risen 60% from last year, while India has seen a 30% increase. Even if these increases slow down, Peabody should still post strong full-year numbers. The company now projects earnings per share of $2.95 to $3.15.

Lower demand from emerging markets, a falloff in global steel production or a continuing limp recovery in the U.S. and Europe could dampen Peabody's near-term prospects. Inflation or a continued rising dollar could do the same thing. None of these developments look like enough to erase the business gains Peabody is making, though. Longer term? What the fundamentals in coal suggest is that explosive demand possibilities indicated by the compelling demographics of China and India will likely outweigh the antipathy for coal due to its environmental effects.

Bottom Line
Peabody is strongly positioned for the global increase in coal demand. Its Australian operations are key to servicing the growing Pacific market. There is also the possibility that U.S. demand will rebound if our economy ever wakes up; this would be a bonus. The best time to have bought Peabody stock was earlier in the year when the stock was shunned, decimated from prior lackluster earnings and awash in a tide of pessimism. Now it's riding high, although the valuation at 11 times next year's earnings looks tempting. Still, savvy investors will buy Peabody, a great company, when the stock cools and coal is momentarily out of fashion again. (For more, see The Industry Handbook: The Utilities Industry.)

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