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Balanced View on Peabody Energy

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On May 9, we issued an updated research report on coal mining company Peabody Energy Inc. (BTU - Free Report) . Peabody is set to benefit from a worldwide revival in metallurgical and thermal coal demand, led by continuous urbanization and industrialization in China and India. However, an oversupply of coal in global markets is putting pressure on prices and affecting profitability.

Peabody Energy, a Zacks Rank #3 (Hold) stock, reported a loss of 19 cents in the first-quarter 2014, much wider than the  Zacks Consensus Estimate of a loss of 1 cent and the year-ago loss of 5 cents. In fact, the reported loss was wider than the company’s guidance of a loss of 10 cents to earnings of 14 cents for the quarter. The downside was mainly due to lower realized prices in spite of higher volumes sold.

The Asia-Pacific region is expected to drive global demand for coal in the next few decades. To capitalize on the demand surge, Peabody is expanding its presence in Indonesia and Mongolia. China is planning to phase out low-quality coal production from its system. As a result, the country is planning to shut down over 1,700 smaller mines with nearly 120 million tonnes of capacity in 2014. This is expected to create fresh demand from China.

Last year, the company entered into an agreement with China’s Shenhua Group to create Sino-Pacific Coal Trading Corporation Pte. Ltd. These initiatives will help to strengthen its footprint in the Asia-Pacific region.

As per the U.S. Energy Information Administration (EIA), coal will hold a share of over 40% of U.S. electric power generation in 2014. Per an EIA report, U.S. coal production in 2014 will increase 4.4% year over year to 1,028 million short tons. The projected increase in coal usage in the U.S. is attributable to higher demand for electricity and the rising cost of natural gas. Peabody’s assets spread across the Powder River Basin and Illinois Basin will help it to benefit from the rising demand.

However, a well-coordinated transport system plays a vital role in the success of coal operators, as the coal producing mines are generally situated far away from the targeted market. Coal sales can significantly decline due to an increase in transportation costs and the lack of sufficient rail and port capacity. Since these factors are beyond the control of Peabody, it could largely impact its sales volume.

Peabody will also have to ward off competition from other domestic coal producers like Alliance Resource Partners (ARLP - Free Report) , Alpha Natural Resources, Inc. and Arch Coal, Inc. .

As a caveat, increasing competition from natural gas and alternate power generation sources will continue to affect the demand for coal. In addition, stringent government regulations on granting permission to coal based power units could negatively impact the future prospects of coal miners like Peabody.

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