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Peabody Energy An Alternative To Crude

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Crude prices continue to show strength and M&A chatter in the mining space does not seem to abate.

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"Your cheating heart will make you weep
You'll cry and cry and try to sleep
But sleep won't come the whole night through
Your cheating heart will tell on you"

-Your Cheatin' Heart (Hank Williams)


My friends - although I am a classic rock guy through and through, Your Cheatin' Heart is one of the greatest songs of all time. To that end I would be remiss if I did not mention that Rolling Stone ranked it #213 on its list of the 500 Greatest Songs of All Time. The song nestled neatly between 1999 by Prince and Rockin' In The Free World by Neil Young.

Many artists have recorded the song. Ray Charles, Elvis and of course the great Patsy Cline. I am sure you all have your favorite rendition, but mine happens to be the version by Loretta Lynn. Now, I know you have all seen Coal Miner's Daughter, the classic 1980 film starring Tommy Lee Jones and the incredible Sissy Spacek ,who won the Academy Award for Best Actress in a Leading Role for her portrayal of Loretta Lynn. It is easy to see why Spacek won the award for her acting but she also sang all the songs herself, as did Beverly D'Angelo in her brief but powerful role as Patsy Cline.

So of course I now have coal on the brain and yet another trading idea born from song.

Peabody Energy (BTU), according to its website, "is the world's largest coal company whose products fuel approximately 10% of America's and more than 2% of the world's electricity."

But coal is anything but "green," even when it talks about "clean coal technology." One of the fears in owning coal stocks is the disdain that any incoming administration may show for coal after the U.S. Presidential Election in 2008. But there is no denying coal as a viable alternative with the best part being most of the coal in the world is right here in the United States. As a matter of fact, I think there is more coal in the U.S. then there is oil in the Middle East.

You are not looking at Peabody Energy or any of the coal stocks as a valuation play. Peabody may in fact be the most expensive of them all, trading at 39.50 times trailing earnings and 21 times forward earnings. Arch Coal (ACI), by comparison, trades at 34 times trailing and 17.50 times forward earnings while Massey Energy (MEE) trades at 30.50 times trailing and 20.50 times forward earnings. On top of that, we have already seen an incredible move in the stock price of BTU already this year, trading right around a 52 week high of $59.99 while starting the year around $37.25. So why chase a coal stock that has already had a monster move?

Well, like it or not, crude oil prices seem destined to stay within the $85 - $95 range we have seen over the last couple of months. Just today, Goldman Sachs (GS) raised its price target for crude oil to $95 from $85 for fiscal year 2008. As long as crude prices stay elevated, coal will remain a viable alternative. But the most compelling reason to be in Peabody Energy may ride on the wave of M&A chatter we are hearing in the mining space.

On November 25th, The Financial Times reported that India may be interested in taking a stake in an overseas coal producer. The article went on to say that India is starting a fund to make a run at a coal company so it can secure supplies for its steel and power industries, coking coal for steel and thermal coal for power plants. Historically, mining companies have avoided making acquisitions in the coal space because of the backlash surrounding the carbon dioxide that is produced from coal burning plants.

But as the "pickings grow slim" in the traditional mining sector, the likes of BHP Billiton (BHP) or Rio Tinto (RTP) may be forced to move in the coal space as the quest for worldwide growth continues. Peabody Energy, although one of the most expensive names on a valuation basis, may be the most attractive to international suitors given the company's exposure to China and the rest of Asia through the mines it owns in Australia. Peabody Energy tripled its presence in Australia following its 2006 acquisition of Excel Coal Ltd.

Peabody Energy currently operates 10 surface and underground mines in Queensland and New South Wales. A Peabody subsidiary also owns 25.5% of the Paso Diablo Mine, the largest coal mine in Venezuela.

Peabody Energy is not sitting still either. Today it was reported in the Wall Street Journal that Peabody is looking to develop coal mines in China. Its Chairman and Chief Executive Officer Gregory Boyce said it would like to sign a deal in the next year to develop an open-pit coal mine in China.

3rd quarter earnings are behind BTU with 4th quarter earnings due to be announced on or around January 24th. But the catalysts before then should be many as crude prices continue to show strength and M&A chatter in the mining space does not seem to abate. BTU is expensive and has had a great run, but I still think this is a name that could go to diamond from coal a lot faster than most people think.
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No positions in stocks mentioned.

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