Name That Trade – $BTU Seams Ready?

by Enis August 20, 2014 3:35 pm • Commentary

The coal sector has been one of the worst-performing areas of the U.S. market over the past 3 years.  Here is the ratio of the coal ETF, KOL, vs. the SPY over the past 5 years:

KOL / SPY, Courtesy of Bloomberg
KOL / SPY, Courtesy of Bloomberg

While the U.S. coal market has stabilized in the past year, as demand has grown and the cold winter reduced inventories, the international coal market still remains under pressure. Still, traders have been eyeing coal for a bounce in the past couple of months as the technicals have improved. Peabody Energy (BTU) has grappled with this recent divergence internationally.  The company derives about 35% of its revenues from Australian coal operations, and that segment has been a particular drag on results, as outlined by management in the most recent quarterly release:

The coal segments that we serve ended 2013 characterized by (1) abundant supply in international markets, which continued to suppress prices in spite of strong demand, and (2) a positive demand outlook in the U.S., with customer coal stockpile inventories having returned to a level that was in line with historical norms. Those trends have continued thus far in 2014 and impacted our results for the three and six months ended June 30, 2014.

The weakness in the Australian division weighed on BTU’s results for the quarter, which were actually much improved in the U.S. as selling prices and demand rose in most regions.  Here is the segment EBITDA comparison of the 2nd quarter in 2013 vs. 2014:

Screen Shot 2014-08-20 at 1.23.14 PM

BTU is a bit of an exception among American coal companies in that it has a large international segment as well. That is one reason why BTU has lagged the broader coal sector somewhat in 2014, though the stock is still highly correlated to the sector as a whole.

On a valuation basis, BTU has traded near book value for the past 2 years, a level that has generally served as support over the last 15 years in BTU (1x Price/Book marked in green) :

[caption id="attachment_44497" align="aligncenter" width="600"]BTU Price/Book Ratio, Courtesy of Bloomberg BTU Price/Book Ratio, Courtesy of Bloomberg[/caption]

The cheap valuation and the improving fundamental backdrop in the U.S. for the coal sector are both positives for investors looking for a potential asymmetric risk/reward situation.

Technically, the stock has held above its July 2013 low of $14.34 throughout 2014:

[caption id="attachment_44498" align="aligncenter" width="600"]BTU daily chart, 200 day ma in yellow, Courtesy of Bloomberg BTU daily chart, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

The 200 day ma is still declining, and BTU remains down 15.5% year-to-date, so not all is well on the chart.  But the 2013 low at slightly below book value provides an important fundamental and technical market for market participants.

In the options market, options traders seem to have re-priced options with the expectation of continued rangebound price action:

[caption id="attachment_44499" align="aligncenter" width="600"]30 day implied volatility in BTU, Courtesy of Bloomberg 30 day implied volatility in BTU, Courtesy of Bloomberg[/caption]

Implied volatility has moved to a 2 year low by a wide margin in the past couple of weeks.  Options traders do not seem to be worried about an imminent breakdown of BTU to new lows at any point over the next 6 months.  At the same time, few are expecting a move back to the May high of $19.63.

While BTU is hardly at the top of my investment list given that the overall business remains unappealing on a long-term basis, the low level of implied volatility combined with the fundamental and technical setup could make for an attractive trade over the next few months.  Doing nothing here, but might get involved in the $15-$16 range.