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Martin Tillier

Martin Tillier

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Peabody Energy (BTU): Time To Pick Up The Knife

There is an old cliché often cited by traders that attempting to catch a falling knife is an extremely dangerous thing to do, but that doesn’t mean that picking one up off the ground isn’t occasionally worth the risk. The phrase “The U.S. coal industry is dead…” has been uttered so many times in the last six months that it has become conventional wisdom. Stocks in the industry have fallen in spectacular fashion, with those companies that have avoided bankruptcy so far losing over 90 percent of their value over the last five years or so. Peabody Energy (BTU) is no exception, but at these super depressed levels BTU may represent an opportunity for nimble traders with an appetite for risk.

The fact is that the coal industry, while undoubtedly in dire straits, is not dead yet, it’s just that stocks are priced that way. That doesn’t mean that coal has a bright future, it certainly doesn’t, but if conventional wisdom is put to one side it is hard to state that it has none at all. Coal still accounts for around 40 percent of the world’s electricity, and according to the IEA, overall demand will rise through at least 2019. Related: The End Of The Beginning For Renewable Energy?

(Click to enlarge)
Figure 1: BTU 5 Year Chart. Source: VectorVest

Coal prices, and stock in companies that produce it, have not tumbled without good reason, however. The big drop in oil prices last year dragged all energy prices with it but coal was particularly hard hit for many reasons. Firstly, the demand outlook for coal has worsened considerably. China has cut imports massively; the total imported fell 42 percent on an annual basis in the first quarter of this year. A political push to reduce emissions, cheaper natural gas and slowing growth in the economy have combined into a perfect storm for coal in what was, until recently, the world’s fastest growing economy. Those same factors have also reduced demand in the U.S. and most of the world…with one notable exception. Related: Fossil Fuel Divestment Could Be A Red Herring

India, the third largest importer of coal in the world, and now the fastest growing economy in the world according to the latest estimates, actually increased coal imports in 2014/5 by a respectable 19 percent. As India imports primarily from Australia and Asia, that is of little use to most U.S. producers, but once again with one notable exception…Peabody Energy. Around 40 percent of that company’s revenue comes from their Australian operations, so they are uniquely placed amongst U.S. producers to benefit from continued growth in India.

That alternative revenue source, combined with some aggressive action by management to cut U.S. costs earlier this month, makes Peabody a likely survivor as the industry collapses, and that, in turn, makes the 97 percent decline in the stock price look somewhat overdone. At around $2.40 at the time of writing, BTU looks like the risk reward ratio has swung in its favor. With over 30 percent of the total stock being sold short, simply a lack of bad news over the next few weeks could be enough to generate a significant rally. There is a downside, for sure, most notably if the current crisis forces a massive increase in insurance costs, but there is an awful lot of bad news priced in at these levels. Related: Midweek Sector Update: Oil Gloom Spreading To Natural Gas Market

It should be stressed that this is a trade idea, not an investment. There is still an enormous amount of risk and a total loss is a possibility, so only capital set aside for high risk trading should be used. It seems, though, on examination of the evidence, that the market is overestimating the risk of bankruptcy for BTU. From a long term perspective investing in a coal company may seem like stupidity in the extreme, but this is not a long term trade. The idea is to benefit from an oversold position at these levels and a short squeeze that will almost certainly come at some point. On that basis a strong argument can be made that the knife that is BTU has already hit the floor, and picking it up here may be a smart thing to do.

By Martin Tillier of Oilprice.com

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