Peabody Shows China Is Coal's Best Recovery Bet

In spite of signs of a gas recovery, Bandy highlights Peabody Energy and Teck Resources as top picks because of their exposure to Asian coal demand. "Anything that is good for China is good for the Australian coal industry, which is good for Peabody Energy," adds Bandy, who says that the company's U.S. assets and those held by Cloud Peak Resources (CLD) in the Powder River Basin of Wyoming and Montana may also withstand a continued near term lull in natural gas prices.

While consolidation between large U.S. coal players has been a big story in the sector, a recent industry slump makes many of those deals, such as Alpha Natural Resources(ANR) acquisition of Massey Energy in January 2011, look mistimed. Volatile commodity prices show that coal M&A carries attendant risks; however, some deals in recent years are key for some rare optimism in the industry.

By many early accounts, Vancouver-based Teck Resources bet the farm ahead of the financial crisis with a $14 billion acquisition of Fording Coal in 2008. Now, the deal and Fording's met coal assets in the Elk Valley of British Columbia are a driver of Teck's earnings, as its coking products are exported to fast growing emerging markets.

Amid a worsening European debt crisis Peabody Energy bought Australian coal giant Macarthur Coal for $5 billion in November 2011, swallowing the acquisition whole after the world largest steel maker, ArcelorMittal (MT) , dropped out what was to be a joint takeover. Peabody's Macarthur deal and a $1.3 billion purchase of Australia's Excel Coal in 2006 are the company two largest acquisitions and a driver of Asia-Pacific earnings growth.

In an early May coal industry outlook reacting to a weaker than expected first quarter earnings season, Credit Suisse analyst Richard Garchitorena noted that met coal is currently the only "bullish" part of the industry. The analyst forecast that coking coal us expected to rise to over $230 a ton in the second half of 2012 from present levels hovering around $220. In the meantime, a slight rebound in natural gas prices shouldn't be cause for optimism, notes Garchitorena, who calculates that energy users won't be incentivized to switch to thermal coal until gas prices rise above $3.

Natural gas is expected to finish 2012 at $2.50 and climb to $3.75 by the end of 2013, said ITG Investment Research chief energy economist Judith Dwarkin at a conference in May.