This long-term-focused value investor has witnessed some screaming bargains over the years as markets responded hastily to near-term developments while losing sight of the big picture.
But I believe the opportunity to acquire shares of Peabody Energy (NYSE: BTU ) beneath $20 apiece, after a visceral reaction to the coal giant's second-quarter earnings, counts among the most glaring value propositions I've encountered of late. My bullish CAPScall on the stock has suffered a gut-wrenching 50% decline; but if you think I'm inclined to throw in the towel, think again. I'm far more inclined to double down on my real-life position at this juncture, and I aim to explain why.
Peabody earned adjusted net profit of $0.73 per share for the second quarter and forced analysts to revise their 2012 earnings expectations downward with guidance of between $0.20 and $0.45 for the third quarter. Coal volumes sold were roughly flat with the prior-year quarter, as increased production from Australia following last year's major Macarthur transaction combined with robust activity from its trading and brokerage unit to offset the impact of substantial weakness in the U.S. coal market. And Peabody is already leading the industry's charge to adapt to weaker domestic demand, most recently by securing strategic export capacity through agreements with Kinder Morgan Energy Partners (NYSE: KMP ) and Union Pacific (NYSE: UNP ) .
I believe that in blasting Peabody Energy's stock down from more than $60 one year ago to less than $20 today, the market is responding primarily to the admittedly woeful destruction of domestic coal demand and related downward revisions to 2012 production and profit expectations. The timing of the $5.2 billion Macarthur transaction near the peak of the near-term coal cycle may also have played a role. In focusing on those factors, however, the market has virtually ignored the resiliently bullish long-term forecast for global seaborne coal demand, and Peabody's unrivaled competitive position to respond to that demand growth. Stated another way, while the near-term profit outlook has diminished, the long-term outlook remains intact for thrilling profitability as worldwide demand for thermal and metallurgical coals progress through a major bullish supercycle.
China's net imports of coal year to date have surged by 74% over the prior-year mark! Even in the midst of a continental financial crisis, European imports of thermal coal increased by 12%. India, whose ongoing build-out of coal-fired electricity generation forms a core driver of the global supercycle, imported 13% more thermal coal year to date. Consider Peabody's latest assessment of the long-term market outlook: "Longer term, Peabody projects an 8 percent compound annual growth rate for seaborne thermal coal demand over the next five years. The company projects that global coal-fueled generation will grow by 390 gigawatts by 2016, which would require more than 1.3 billion tonnes of additional thermal coal." In relation to increased global demand on that scale, this year's projected dip in U.S. domestic demand of 100 million to 120 million tonnes needs to be kept in its proper context.
Based on projections for a 25% increase in global met coal demand by 2016, "Peabody projects a 9 percent compound annual growth rate in seaborne metallurgical coal demand over the next five years." Accordingly, I hold investment stakes in both Peabody Energy and Teck Resources (NYSE: TCK ) , since both miners are well positioned to direct their strategic met coal assets into the Pacific trade.
It's worth noting, finally, that four analysts I'm aware of reiterated their "buy" or "outperform" recommendations Wednesday after reviewing Peabody's earnings. Although each of them revised their price targets downward, the average of those new targets was $31 per share, or more than 60% above the current share price at the time of this writing! Even in the midst of a painful coal-stock implosion, I'm eager to take my chances that Peabody's shares will appreciate handsomely from these levels.