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Insiders Say Coal-Powered Spin Off Holds Promise
By Michael Brush
Exclusively for InvestorIdeas.com
December 06, 2007
Investors often make big money in corporate spin-offs when they buy them right out of the gate. The odds of success improve when insiders purchase in the opening days, as well.
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That’s what we see at the recent spin off of Patriot Coal (PCX) from coal giant Peabody Energy (BTU). Since November 23, Patriot insiders have purchased a cool $4.3 million worth of their company’s freshly-minted shares.
Another twist that makes these purchases especially intriguing: Insiders keep buying on the way up. They began buying in the $31-$33 range in late November. And they’ve continued to purchase the stock as it recently moved north of $35, according to InsiderScore.com.
Since these insiders have spent decades in the coal business at Peabody, I’ll take it that they are more like savvy buyers than day traders chasing initial public offerings of Internet stocks in the late 1990s.
What do these insiders see in Patriot? Here’s my take on the major company-specific and industry trends that could push Patriot stock higher in the coming years.
* Patriot is big. At a time when sky-high oil prices make coal look even more attractive as an energy source, Patriot is sitting on a lot of the stuff.
The company controls about 1.4 billion tons of proven and probable coal reserves at sites in Appalachia and the Illinois Basin. That’s more than the amount of coal used in the U.S. in an entire year. The company has one of the largest reserves in Appalachia, and it is a major reserve holder in the Illinois Basin.
* Patriot could be a consolidation play. The U.S. coal industry has been in a major consolidation trend for the last 15 years. In 2005, the five largest coal producers controlled over 53% of coal produced in the United States, compared to 25% in 1990.
But the sector is still fairly fragmented, especially in Appalachia where Patriot has a big presence. As one of the bigger players in that region, Patriot stands to benefit from the consolidation trend – especially now that as a public company it can raise funds to make purchases. Patriot’s management team cut its teeth at Peabody, so they know the ropes on acquisitions.
* Patriot has a broad mix of assets. The company holds a mix of medium- and high-energy content steam coal; coal with low, medium and high sulfur content; and coal used to produce steel. So it is well-positioned to meet demand from lots of different kinds of buyers – including utilities with varying types of sulfur dioxide emissions control devices, or scrubbers.
Patriot gets about a quarter of its revenue by selling premium “metallurgical coal” to steel mills and independent coke producers, including international customers in Europe and Brazil. Metallurgical coal is converted into coke used in making steel, by heating it to a very high temperature in the absence of air. “Metallurgical coal continues to sell at a significant premium to thermal coal, and we expect to capitalize on the strong global market for it,” says the company.
* Patriot has good industry connections. The seven top executives have a combined 134 years of experience in the mining industry, at Peabody. They will continue to sell coal to various Peabody subsidiaries.
Industry trends look bullish
Coal is the most common fuel used to generate electricity in the U.S. Coal-fired plants generate about half the nation’s electricity, followed by nuclear plants at just 20%. It’s easy to see why coal is so popular as a source of power for producing electricity.
First off, it is cheap. Coal cost about $1.48 per million British thermal units (Btu) of energy, compared to about $6.74 per million Btu in 2005 for natural gas, in 2005.
Next, it is abundant. Coal makes up more than 85% of fossil fuel reserves in the United States. The nation has a 250-year supply of coal.
The use of coal to generate power will continue to increase because so many coal-fueled power plants are coming on line. Patriot estimates that coal-fueled capacity around the world will increase by about 10% over the next three years, from projects under construction. The Energy Information Administration estimates coal-fueled generation in the U.S. will increase about 45% by 2030, or by more than 500 million tons of coal.
Increased global demand for steel and electricity also boosts demand for coal – especially from high-growth economies in places like China and India. Patriot doesn’t sell coal there, but the demand lifts global coal prices.
Coal demand will get a boost from wider use of coal conversion technologies that allow gas and liquid fuels to be made from coal.
Higher oil prices and increasing interest in the U.S. for greater energy independence, also support long-term demand for coal.
The bottom line: If Patriot is so attractive, why is Peabody selling it? Patriot filings explain that Peabody is increasingly becoming a global player, so it doesn’t need the distraction of figuring out how to develop a regional Appalachian and Illinois Basin asset base. I’ve heard better explanations for spin offs, but given the voracious appetite by Patriot insiders for their company’s stock, it’s probably best not to be too cynical about this one.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner:
http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.
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