Ignore Wall Street – Buy Peabody Energy

The insanity on Wall Street continues. The talking heads on CNBC  tell viewers that the economy in the US is in much better shape than economies elsewhere in the globe. They say that the financial crisis in the US will affect other economies around the globe more deeply than the US.

The talking heads go on and urge viewers to “bottom-fish” the fabulous bargains in the financial stocks. In the same breath, they tell viewers that the global growth story is dead and avoid anything related to global growth or commodities.

Please don’t believe them! First of all, I never trust a guy in a high-priced suit who is sweating profusely. He is probably lying.

Think of the logic of what the talking heads are telling you to do. A nuclear blast has gone off in the middle of Wall Street. They are urging you to run at full speed towards the blast. Logic dictates that you run full speed away from the blast. 

Fundamentals for Coal

I believe that the global growth story is not dead. Its death has been greatly exaggerated by Wall Street.
Look at the latest monthly oil import figures from China – up 14%. Some slowdown! One area of relative safety that has been little effected by the damage on Wall Street is coal.

Don’t get me wrong. Coal stocks have been ravaged by the morons on Wall Street who are blindly selling everything. Yet the underlying fundamentals have little changed. Prices for both coal and iron ore have held up very well during this Wall Street chaos.

Worldwide steel demand has grown at a 6% annual rate stoking demand for metallurgical coal. Despite the global “slowdown”, steel demand should continue to grow at a 4% – 5%  over the next several years led by steel demand in China and India.

Thermal coal demand continues to rocket higher, driven by the electrification of the emerging markets around the globe. Despite what Wall Street may think, increasing demand for thermal coal has not slowed and shows no signs of weakening any time soon.

Bottlenecks

All major coal exporters are straining to keep up against this sustained demand growth for thermal coal. Earlier this year, there were major stockpile shortfalls of thermal coal in many major emerging markets including: China, India, Indonesia, South Africa, and Chile. China’s stockpiles of thermal coal still remain critically low, at approximately a 3-day supply.

The pressures on coal are coming from both the supply and the demand side. As stated earlier, most emerging markets are engaging in huge efforts to electrify their countries. For instance, in China alone there are 80 new coal-fired power plants scheduled to come on line before year-end.

On the supply side, there are major infrastructure problems holding back the supply. In the major coal exporting nation of Australia, their port facilities currently are simply inadequate to meet the demand for coal. At Australia’s main coal exporting facility at Newcastle, ships wait in line literally for weeks to be loaded with coal. This situation is expected to improve somewhat in 2010 when rail and port capacity expansions are completed.

Other nations such as South Africa face other problems. In South Africa, the actual lack of sufficient electricity is holding back the production of coal at their mines. The problems with the power grid in South Africa may not be solved for years. Similar problems can be found in Chile and Indonesia.

Connect the Dots

It is easy to see how the global coal market is interconnected. China and India are now sucking in all the coal they can from Australia, Indonesia, Vietnam, and South Africa. Europe, in the past, heavily relied on the imports of coal from South Africa. That coal is no longer available to them because the Chinese are out-bidding them for the available coal.

So the Europeans have turned to the United States to supply their coal needs. The United States has now become the key swing producer of coal globally. The company best positioned to take advantage of the new reality in coal is Peabody Energy.

Peabody Energy – the Company 

125 year old Peabody Energy, symbol BTU, is the world’s largest private-sector coal company, with 2007 sales of 238 million tons of coal and $4.6 billion in revenues. The company’s coal products fuel approximately 10 per cent of  all US electricity generation and 2 per cent of worldwide electricity generation. At 9 billion tons of coal, Peabody’s reserve base is the industry’s largest.

Peabody Energy has coal operations throughout the US, including in the rich Powder River Coal area of Wyoming. The company’s North Antelope Rochelle Mine is the largest and most productive coal mine in North America. That mine alone shipped an industry record of 91.5 million tons of low-sulfur coal last year.

Unlike many US companies, Peabody Energy has expanded its horizons globally. Five years ago, the company generated only 1% of its earnings from outside the US. Currently, Peabody Energy generates more than half of its earnings from outside the US.

Peabody in Australia

Peabody Energy has wisely expanded its coal operations into Australia. Nearly one-third of all the world’s coal exports and 60% of the world’s seaborne metallurgical coal come from Australia.

In October 2006, the company began their move in earnest into Australia with the purchase of Excel Coal. Peabody Energy currently operates 11 mines producing thermal and metallurgical coal in Australia. The company’s Australian operations together produced 21 million tons of coal in 2007, up sharply from 11 million tons the prior year.

Peabody recently announced that the company has completed a $50 million expansion of its mining complex in New South Wales, Australia. The expansion included development of a mine expected to produce more than 2.5 million tons per year. The complex’s primary mine produced more than 4 million tons last year.

Peabody Energy – Stock Performance

As I stated earlier, Peabody Energy’s has been beaten down like other commodity-related stocks by the insanity on Wall Street. In late June, Peabody hit its 52-week high at $88.69. Then the selloff began. Just recently, the stock hit its 52-week low of $42.05. The stock has since rebounded somewhat and as of this writing, it is trading at about $57 a share.

With this drop in price, Peabody is now back to where it was a couple of years ago. I urge investors to purchase the stock at these levels. Peabody is a true growth story and a play on global electrification. The emerging markets around the world are not going to stop trying to raise the standard of living for their citizens just because some Wall Street guys from the Hamptons think they should.

Action to take: In addition to purchasing shares at the current price, we recommend an off-side options bull spread. Purchase two January 2009 BTU calls (symbol: BTUAK) for every one January 2009 BTU put (symbol: XZVMJ). The reason we chose the January options is for the undervaluation and a beta of 1.56 (normally moves 1.56 times more than the market) this stock is sure to see some significant movement over the next four months. The put options will protect us on the downside.

Tony D’Altorio
Analyst, Wall Street Elite