Peabody Shows China Is Coal's Best Recovery Bet

Increasingly, steel demand led by emerging market powerhouses like China and some economically advantaged thermal coal basins like Powder River are the industry's best hope after a 40% drop in the Dow Jones U.S. Coal Index (DJUSCL) in 2012.

Credit Suisse highlights Peabody Energy as its top sector pick due to the company's Australian and emerging market assets. In a late May reappraisal of the coal industry, Goldman Sachs raised its outlook for the sector to attractive from neutral, and highlighted Peabody as its only new buy-rated company.

Goldman Sachs analyst Andre Benjamin highlighted the improving performance of Peabody's Australian unit after its Macarthur Coal acquisition and the company's overall growth outlooks as reasons for his upgrade. At the same time, Benjamin cited an improving performance of Peabody's Australian unit after its Macarthur deal and the company's growth outlook as reasons for his upgrade.

"We have a less favorable view of the most CAPP thermal- and US metcoal-focused producers within our coverage," wrote Benjamin in the May 28 note that cited valuations, regulatory pressures and leveraged balance sheets as concerns for U.S. centric players.

The expected outperformance of Peabody, a St. Louis-based company with a history that traces back to the late 19th century, should be taken as a context in how investors may want to target any recovery investments in the beaten down sector.

For instance, in spinning off its longstanding operations in West Virginia and Kentucky into Patriot Coal(PCX) , a top thermal producer in the East, Peabody has continued to tilt its asset base to Australian met coal and the Powder River Basin.

In hindsight, that spinoff minimized Peabody's exposure to thermal coal in the east and may have been done under advantageous terms, according to Bandy of BMO. After a rapid surge in its shares after the spin on quickly rising natural gas prices, Patriot cut a few medium sized acquisitions to grow its scale in the U.S. Now, the company's fate has turned for the worse on slumping natural gas prices. In May, Patriot said it hired The Blackstone Group(BX) to help with its refinancing efforts amid a cash crunch that has some analysts handicapping the company's bankruptcy.