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Peabody Energy Corp. stands to profit from necessity of coal

by Katharine Lau
Feb 04, 2010


ILBasin2

Illinois State Geological Survey

The Illinois Basin stretches across Illinois, Indiana and Kentucky.

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Google Finance

Peabody's stock (the blue line) has  performed well above the S&P 500 (the red line) over the past 12 months.

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New York Stock Exchange

Compared to its competitors on the New York Stock Exchange, Peabody's price to earnings ratio places it around the middle.

Peabody Energy Corp., the world’s largest private-sector coal company, has not forgotten about its operations in the Illinois Basin under Illinois, Indiana and Kentucky. 

Though the St. Louis-based company has shifted the majority of its attention to its Australian and Mongolian assets to capitalize on India’s and China’s growing demand, Peabody continues to expand in the U.S. as well.  The coal mining giant’s coal products fuel 10 percent of all U.S. electricity generation.

Growing demand in Asia for coal overrides analysts’ concerns about possible tighter U.S. regulation of coal. They estimate Peabody's earnings per diluted share will rise this year to $2.78, according to Bloomberg LP. Last year the company's profit dipped to $448 million, or $1.66 per diluted share, after record 2008 earnings of $953 million, or $3.50 per diluted share.

Sales totaled $6 billion in 2009 and $6.6 billion in 2008. 

Davenport & Co. LLC analyst Garrett Nelson gives Peabody stock a “buy” rating and a target price of $55 compared with current trading around $42. The stock’s 52-week low was $20.17 and the 52-week high is $52.14. Nelson wrote in a Jan. 27 note: “We view Peabody as uniquely positioned to serve higher-growth Asian/Pacific markets, with the potential for meaningful U.S. upside in the 2011-2012 timeframe.”

Analysts' consensus target price is $56.53, according to Bloomberg LP.

Over the past 52 weeks Peabody’s stock has risen twice as fast as the Standard & Poor's 500 Stock Index.  However, compared to other coal companies, Peabody’s price to earnings ratio of 26 places it in the middle of the pack. The stock continues to trend upward. 

Coal has sparked much public debate the past few years due to an increased focus on concerns about global warming.  Coal usage produces a significantly greater amount of carbon emissions than other sources of fuel such as petroleum and natural gas. 

Peabody operates the Gateway, Wildcat Hill Complex and Willow Lake Underground mines in southern Illinois, and it will spend $60 million related to their share of the Prairie State Energy Campus this year, said Michael Crews, Peabody chief financial officer, in a Jan. 26 teleconference. 

Prairie State, a project slated for completion by 2012, is a new power plant and a coal mine in Washington County, Ill.  It promises to provide electricity to 2.5 million families in nine states, “revitalize the Illinois economy with $785 million in annual economic activity” and produce carbon emissions 15 percent lower than the typical U.S. coal plant, according to the Prairie State Web site.  Prairie State is 5 percent owned by Peabody and 95 percent owned by eight public power companies located across five states. 

Peabody expects the Illinois Basin and the Powder River Basin in Montana and Wyoming to support the majority of the U.S. coal market, according to Peabody’s Jan. 26 press release. 

“A couple of years ago when the markets were strong in 2008, we exported a lot of business out of the Illinois Basin and did some blending of our Illinois Basin coals to our Colorado coals,” said Richard Navarre, Peabody chief commercial officer, in a Jan. 26 teleconference. 

The current market for coal in the U.S. and Europe, however, does not make it profitable enough for Peabody to consider exporting U.S. coal.  So for now, Illinois coal will stay in the domestic market, which doesn’t faze analysts too much. 

Morningstar Inc. analyst Michael Tian expects U.S. margins will expand during the next five years, according to his Jan. 26 note. 

“We project Midwestern U.S. margins will be around $10.50 per ton and western U.S. margins will be around $5.65 per ton in 2013 versus $5.20 and $4, respectively, in 2008,” Tian wrote.  

But Tian did express concern about the U.S.’s potentially increasing environmental regulations and deciding to cap carbon emissions, which could affect Peabody materially – a concern other analysts echo. 

“Adoption of new [nitrogen oxide] standards, which started in 2004, can reduce market demand for coal and cause buyers to back out of, or renegotiate, existing contracts,” Friedman Billings Ramsey & Co. analyst David Khani wrote in a Jan. 27 note. 

Nevertheless, Khani gives Peabody stock an “outperform” rating and assigns it a target price of $65, based on the belief that Peabody is “positioned to capitalize on the long-term growing Asian market.” 

“We’re not anticipating a detrimental effect in terms of coal burn or ultimately the full-end cost of coal production,” CFO Crews said in the teleconference, in response to Simmons & Co. analyst Pearce Hammond, Jr.’s concerns about potential coal ash regulations in the U.S.

Michael Murphy, a manager in the Illinois Office of Coal Development, said decades of “halfway start and stop regulations with different administrations” have complicated the future of coal.  Public policy, according to Murphy, has not helped coal’s image, either. 

“There’s nothing fundamentally evil about a fossil fuel that, if you needed it, you’d be happy to have it,” Murphy said. “The question is, what are the alternatives? What are the consequences and costs?”

Carbon sequestration is one idea to help combat carbon emissions.  However, the technique, which involves the capture, storage and burial of carbon dioxide, can work only on future, not current, carbon dioxide levels. 

Murphy added that coal is a $2 billion industry in Illinois, and the state stands to produce 51 million tons of coal per year when new generation coal facilities are completed.  Illinois produced almost 33 million tons of coal in 2008. 

“A lot of people like to say [coal] is a southern Illinois industry.  It’s not,” Murphy said.  “It’s a southern and central Illinois industry – regions that need workers.” 

Coal underlies about 65 percent of Illinois’ surface, and the state ranks ninth among coal producing states, according to the state’s Department of Commerce and Economic Opportunity. Over 90 percent of Illinois coal goes to the electric utility industry, with Illinois utilities using on average 3.5 million tons of that coal each year, and about 75 percent being sold to out-of-state utilities.  According to Murphy, 3,400 people work in the Illinois mines, and indirectly the industry sustains jobs to five times that many. 

“The nation cannot afford not to use coal,” Murphy said.