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No BTU Blues

By Stephen D. Simpson, Simpson, – Updated Nov 15, 2016 at 7:03PM

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Despite some shipping difficulties on the horizon, the outlook for coal is rock-solid.

There was a time when getting a lump of coal in your stocking was supposed to be a sign that you were in Dutch with Santa Claus. Well, if coal prices stay astronomical, in just a few years' time, that lump of coal will sell for more than an Apple iPod. Yeah, it may be dirty, and it can definitely be dangerous to mine, but there's gold in "them thar" coal mines.

And as the big chief in coal mining, nobody understands that better than Peabody Energy (NYSE:BTU). This fourth quarter capped off a torrid year for the coal markets, with revenue rising almost 21% atop only a 3% rise in tons sold. In fact, so strong were coal markets this year that Powder River Basin coal's price more than tripled in the year.

Along with higher prices and stronger revenue came good cost control. Overall operating costs per ton were flat in the U.S. (and up in the single digits for individual regions) and much higher in Australia, but overall operating income was still up more than 91% from the year-ago period.

That said, there was a hitch in the company's guidance that initially spooked investors. Railroads like Union Pacific (NYSE:UNP) and Burlington Northern (NYSE:BNI) are still challenged when it comes to shipping PRB coal, and that's going to cut into the company's production figures. Unfortunately, operating costs are going to remain high. In other words, results from the first quarter are going to be lower than initially thought, and some of that might flow into later quarters, as well.

On a longer-term basis, though, the market still looks very strong. That rail-induced shortage isn't going to hurt prices, and coal is still undervalued relative to oil and gas on an energy content basis. Granted, some discount is warranted by the efforts needed to make coal more usable, but there is more and more talk of gasification and liquefaction plants going up -- including one that will involve Peabody and use technology from ConocoPhilips (NYSE:COP) to make synthetic natural gas.

When it comes to modeling a good cash flow target for Peabody (or other coal companies like Arch Coal (NYSE:ACI), Massey (NYSE:MEE), or Foundation (NYSE:FCL)), I wish you good luck. It's quite a trick to accurately project coal prices, production levels, and operating costs years into the future, and I don't pretend to have those answers.

I'm not saying, "It's different this time," nor am I saying that coal prices have reached a permanent higher plateau. But with coal prices still heading higher, little relief in sight, and a lot of uncommitted production still left to be signed into contracts, the future for Peabody looks pretty appealing.

For more Takes on the coal sector:

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares.)

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Stocks Mentioned

Union Pacific Corporation Stock Quote
Union Pacific Corporation
UNP
$203.97 (-2.49%) $-5.20
Peabody Energy Corporation Stock Quote
Peabody Energy Corporation
BTU
ConocoPhillips Stock Quote
ConocoPhillips
COP
$100.59 (-8.60%) $-9.47

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