Peabody, Cheap For a Reason, Could be Just Plain Cheap in a Coal Turnaround

‘Tis the season to worry about ending up with a lump of coal in your stocking – but perhaps not to fret quite as much if you happen to have a coal mining stock like Peabody Energy Corp. (BTU) in your portfolio.

True, you may not want to chase Peabody’s stock higher – or aggressively pursue those of any other coal mining companies. The whole sector has been battered by the plunge in natural gas prices early this year, which triggered a wholesale switch on the part of utilities to using the lower-cost fuel in preference to coal to generate power. Meanwhile, many coal mining companies, including Peabody, have been grappling with higher costs.

BTU Expenses Quarterly Chart

BTU Expenses Quarterly data by YCharts

Why consider the stock at all? Two words: valuation, and turnaround. The company’s PE ratio has been cut almost in half during the last two years and now trades at a reasonable discount to the S&P 500. But that wouldn’t matter much if it weren’t for the fact that as yet, little prospect of a turnaround appears to be priced into Peabody’s stock price. The price for thermal coal appears to be edging higher amidst signs of resilient demand from China – easily the world’s largest single consumer. And the company itself indicated last week to analysts that it expects its earnings for the first quarter of 2013 to mark the trough in the current cycle.

BTU PE Ratio TTM Chart

BTU PE Ratio TTM data by YCharts

Peabody already did better than most analysts expected in the third quarter, when it reported better-than-expected EBITDA and free cash flow. It also has been aggressively cutting costs: its capital spending in 2013 will be about half of the $1 billion or so it expects to end up spending this year, and it is eliminating jobs and slashing other expenses. One of the key reasons that so many commodity producers have suffered – and their share prices along with them – is that they have locked in higher costs in the form of big output expansions at a time when commodity prices slumped. Peabody has moved more rapidly than many others to address this situation.

BTU Cash Flow to Capex Chart

BTU Cash Flow to Capex data by YCharts

While awaiting a turnaround in the fundamentals, it’s important to note that measures of Peabody’s liquidity or credit quality are either stabilizing or improving as the company forges ahead with measures to cut debt. That might give investors anxious about the company’s outlook some comfort that there is a cushion, and potentially even some upside potential should predictions of stronger Chinese demand prove correct. This is an under-loved and underperforming sector of the market that just may prove able to generate some outperformance as it bounces off its lows in 2013.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.

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