Peabody Energy Corporation: What People Are Missing

Slumping coal prices continue to hurt the coal miners, including global leader Peabody Energy (NYSE: BTU  ) . The company reported fourth quarter earnings that generally beat market estimates, but the stock slumped due to the outlook for 2014.

While coal prices continue to slump, domestically focused investors are missing the reasons. The general consensus is a lack of long-term demand, but the reality couldn't be further from the truth. In fact, Peabody reported that 2013 global coal demand hit a record. In addition, the company forecast global coal demand to rise by 700 million tons by 2016 led by urbanization and industrialization in China and India. For reference, Peabody forecast sales of roughly 255 million tons in 2014, making the growth equal to two to three new similar sized companies.

Sales volumes increased
A fact that might surprise some investors is that Peabody generated a sales volume increase of 1% during 2013. The main reason for the rise was a 6% gain in shipments from Australia. Overall revenue slumped, however, due to a 22% decline in revenue per ton. Domestic operations were more stable with a 4% decline in both prices and volumes.

Unfortunately, Peabody expects U.S. costs per ton decline 1% to 3%, less than the 5% to 8% slump in revenues per ton. So even after a year of impressive results in the face of a weak market, the company actually expects a worse year in 2014. Earnings are expected to drop to near breakeven after reaching $0.34 for 2013. Revenues could actually be stable with higher demand for coal around the world.

In this scenario, Arch Coal (NYSE: ACI  ) might be forced to cut more coal production with large losses of over $1 expected again in 2014. In addition, CONSOL Energy (NYSE: CNX  ) is shifting focus toward natural gas. During the fourth quarter, the company sold five coal mines in West Virginia while acquiring 90,000 acres in the Marcellus Shale. Compared to Arch Coal and even Peabody, CONSOL Energy might be onto something with the focus on natural gas. Analysts expected the company to earn over $1 in 2014. Even more impressive, investors are more confident in the stock with it currently trading at roughly 32x the forecasted estimates for 2014.

Global demand growth
While domestic demand remains a major wildcard based on natural gas prices, the global prospects appear very strong and Peabody is very well positioned in Australia to serve the Pacific Rim.

Both China and India's coal generation grew by nearly 10% in 2013 with forecasts for more strong growth over the next couple of years. Japan continues to grow coal use with the addition of new coal-fired power plants. In total, approximately 250 gigawatts of new coal-fueled generation will be built in the next three years, requiring 750 million tons of thermal coal.

Bottom line
The results for coal miners continue to drag along the bottom, but the demand equation continues to improve while the supply situation will continue to worsen. Domestic miners already have limited incentives to expand operations and the global miners will follow suit with the forecasted drop in global coal prices. When short-term investors expect the worst, long-term investors can swoop in. With rising demand and limited incentives to increase production, the supply situation could change dramatically in a short period. If anybody wants an example of such a scenario, they need to look no further than the soaring domestic natural gas prices. What appears to be a straightforward, struggling industry could in fact turn around very quickly.

What should investors be eyeing in 2014?
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