Peabody Energy (BTU), based in St. Louis, Missouri, is the world's largest private-sector coal company, with operations in the US and Australia. The company ships over 220 million tons of coal annually through its global integrated platform and employs approximately 7,000 individuals. It is the leading producer in the Powder River Basin (PRB) and also one of the largest met coal producers contributing to the seaborne market. Peabody controls approximately 9.3 billion tons of coal reserves in Illinois, Indiana, Kentucky, Wyoming, Montana, Arizona, New Mexico, Colorado, Queensland and New South Wales. Given current valuation of BTU's share price and asset quality, the stock is extremely undervalued and will outperform the market over the next several years.

Peabody’s Q2 adjusted EPS of 33 cents greatly exceeded the Street’s expectation of a 5 cent loss. The adjusted EPS includes a $148 million income tax benefit. Management partially offset weak seaborne pricing with impressive operating cost and capex reductions. Domestic thermal fundamentals continue to improve in preferred basins, PRB and ILB. BTU’s valuation on 2015 results is very attractive. Peabody reduced 2013 Australian cost guidance from $80 per ton to mid-$70s per ton. The cost reduction is a result of productivity improvements, mine conversions to owner-operator and a weaker Australian dollar. Australian costs decreased 5% q/q to $73.39/ton. Met coal sales increased 14% q/q to 4.1 million tons while the average realized price was down $1 to $123/ton. Seaborne thermal coal sales declined from 2.7 to 2.6 million tons while the realized price fell $10 to $77/ton. Australian sales guidance remains unchanged at 33-36 million tons in 2013. U.S. sales of 44.1 million tons was flat q/q. Revenue per ton was flat and cost per ton increased 1% q/q. U.S. sales guidance remains unchanged at 180-190 million tons.

Domestic thermal fundamentals continue to improve. Customer inventories of PRB coal are down over 25% y/y to about 60 days. I believe producers will regain pricing power as stocks continue to decline. In 1H, coal consumption for power generation increased 11% y/y while coal shipments were down 5%. Power generation from natural gas in 1H was down 15% y/y. Peabody indicated that seaborne coal demand remains strong and expects seaborne thermal demand to grow 50 million tons in 2013. Peabody expects curtailments in China and reduced exports from the U.S. to bring the oversupplied seaborne market closer to balance in 2H. Management noted that reports indicate that 45% of Shanxi producers are unprofitable at current prices. And, U.S. coal exports declined 30% in June.

Peabody reduced 2013 capex guidance by $100 million to $350-$450 million. Management continues to aggressively manage costs. Peabody expects 3Q13 adjusted EBITDA in the range of $210-$270 million and adjusted EPS of ($0.16) to $0.09.

I believe Peabody's valuation reflects a bearish outlook for both U.S. and global seaborne coal fundamentals. I remain confident that such a view is unfounded. In particular, there is excessive skepticism due to recent PRB spot market trends. Over time, I expect PRB pricing to strengthen and BTU shares to trade higher.

I am long BTU.