Were Billionaires Wrong or Early on Peabody Energy?

Coal company Peabody Energy Corporation (NYSE:BTU) saw some billionaires buy in during the second quarter of the year. Our database of 13F filings shows that billionaire Israel Englander’s Millennium Management increased its stake in Peabody by 77% to a total of 1.4 million shares (see more stock picks from Millennium Management). D.E. Shaw also added shares and closed the second quarter with 1.5 million in its portfolio (find more stocks owned by D.E. Shaw) and Renaissance Technologies, founded by Jim Simons, bought over 3 million shares and owned 3.6 million at the end of June (research other stocks that Renaissance liked).


However, Peabody Energy Corporation generally declined during the second quarter; it started April at just below $30 per share and finished June at about $25 per share. Currently between $22 and $22.50 per share (the stock is down a total of 39% over the last year), while we don’t know precisely where these funds bought in we think we can safely say that they have likely lost money so far. Certainly any shares that they still own should be well below their entry point.

The entire coal industry has been hit hard by rapidly growing natural gas production in the U.S., which has driven down natural gas prices and led utilities to substitute natural gas for coal. The Energy Information Administration’s Electric Power Monthly shows that 648 million megawatt-hours were produced by utilities from coal in the first seven months of 2012, down 17% from the same period in 2011. The decline did seem moderated in the summer months, though that may be due to higher seasonal demand for electricity. Peabody Energy Corporation, which provides both thermal coal and metallurgical coal, actually increased its revenue by 8% in the first half of the year compared to the first six months of 2011 but thanks to higher costs its earnings were down 18%.

Wall Street analysts believe that Peabody’s business will continue to deteriorate. Even though the stock trades at 7 times trailing earnings, which would normally lead it to warrant consideration as a value stock, forward earnings estimates imply a P/E of 11 on that basis.  That still seems cheap, and it is possible that at some point energy-related coal demand will stabilize, particularly if Chinese markets become open for U.S. coal exports.

Four fellow coal producers are Walter Energy, Inc. (NYSE:WLT), Arch Coal Inc (NYSE:ACI), CONSOL Energy Inc. (NYSE:CNX), and Alpha Natural Resources, Inc. (NYSE:ANR). CONSOL is a bit larger than Peabody in terms of market cap, posting a $7.1 billion valuation compared to Peabody’s $6.0 billion. The other three companies are in the $1-2 billion market cap range. Arch Coal and Alpha are not only unprofitable on a trailing basis, but also expected to have negative earnings in 2013 as well. Interestingly, both of these companies got a gain in revenue in the second quarter of the year versus the same period in 2011. With these stocks down 60-70% over the last year, they may have better upside from a coal recovery if they can claw their way back to profitability.

Walter and CONSOL, like Peabody, see higher P/E multiples on a forward basis than on a trailing basis. They trade at 11 and 20 times forward earnings estimates, respectively. These companies saw lower revenue last quarter than a year ago, though CONSOL saw higher earnings. Walter seems to be quite similar to Peabody in terms of valuation, though we think it’s probably better to pick a company which is seeing sales growth.

We think that Arch and Alpha likely have a larger upside than Peabody, but also has a considerable downside as their industry is struggling and they are unprofitable. Peabody should at least be profitable next year if analyst expectations pan out, and is thus a safer pick though we would want to see continued recovery in coal.