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Executives

Vic Svec – SVP, IR and Corporate Communications

Greg Boyce – Chairman and CEO

Mike Crews – EVP and CFO

Rick Navarre – President and Chief Commercial Officer

Analysts

Michael Dudas – Jefferies

Paul Forward – Stifel Nicolaus

Pearce Hammond – Simmons & Company

Brian Singer – Goldman Sachs

Jim Rollyson – Raymond James

Kuni Chen – Bank of America-Merrill Lynch

Mark Caruso – Millennium Partners

David Conti [ph] – FBR Capital Markets

John Bridges – JPMorgan

Shneur Gershuni – UBS

Meredith Bandy – BMO Capital Markets

Jeremy Sussman – Brean Murray

Peabody Energy Corporation (BTU) Q3 2009 Earnings Call Transcript October 20, 2009 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Peabody Energy Third Quarter Earnings Release Conference Call. During the conference, all participants are in a listen-only mode. However, there will be an opportunity for your questions and instructions will be given at that time. (Operator instructions). And as a reminder, today's call is being recorded.

With that being said, I'll turn the conference now to the Senior Vice President, Investor Relations and Corporate Communications, Mr. Vic Svec.

Vic Svec

Okay. Thanks, John and good morning, everyone. Thanks for taking part in the conference call this morning for BTU. With us today are Chairman and CEO, Greg Boyce; Executive Vice President and CFO, Mike Crews; as well as President and Chief Commercial Officer, Rich Navarre.

We do have some forward-looking statements and they should be considered along with the risk factors that we noted at the end of our release, as well as the MD&A section of our filed documents. And we also refer you to peabodyenergy.com for added information.

With that, I'll turn the call over to Greg.

Greg Boyce

Thanks, Vic and good morning, everyone. Peabody turned in a very strong quarter, driven by record Australian met volumes and expanded U.S. margins. Our cash and liquidity levels have increased as we continue to demonstrate the power of Peabody’s global business model, delivering value across multiple markets in varying conditions.

Mike will review our quarter and Rick will discuss Peabody’s sales and trading positions. But I’d like to set the stage with a summary of our insights into the core markets and Peabody’s unique position.

Overall, global economies are improving and GDP expectations have been revised upward. But behind the macro story are very divergent markets between the Pacific and the U.S. Atlantic regions. No surprise, China and India continue to lead the way in both economic expansion and coal demand growth. For instance, India has reported 10.4% growth in industrial production for the latest period. Swift implementation of stimulus plans on infrastructure and a build-out of new coal base generation is driving robust demand for steel in both China and India. And as a result, they are the only steel producing majors to increase production this year.

Fundamentally, China and India face limited domestic supplies of high-quality met coal products. In fact, we are convinced that China is structurally short met coal, particularly in the high end. And this has profound long-term implications. China’s growth will continue and now that other countries in the Pacific Rim return to their high pre-recession growth rates for coal, we are seeing demand against stretching supply and pushing prices north of their settlements for both met and thermal coal.

Now, China has been a positive import surprise, but India reports that it may be up to 200 million tons per year short of coal by 2014. And even if imports can’t satisfy this entire shortfall, it’s clear that India will turn to the seaborne markets for substantial volumes. Over the next five years, we believe global seaborne coal could grow at a hefty 7% to 8% compound annual growth rate or 300 million to 400 million tons per year. This extraordinary demand will chronically leave the world undersupplied.

So where will the new supply come from to serve this demand? Well, Australia is the largest and best beneficiary, likely supplying half of the world’s growth. Secondary to Australia is Mongolia, which will be, over time, a natural provider of met and thermal coal to China. Indonesia, which will satisfy part of India’s thermal coal needs and we believe longer term the best U.S. role in providing Asian coal growth will likely be through the West Coast, using Power River Basin products.

Peabody has access to multiple regions and major transportation infrastructure, especially through our growing Australian production platform. We will be able to capitalize on this growth. In addition, Peabody recently established a new trading hub in Singapore, creating a central location to serve Asian demand, as well as opening a representative office in Jakarta.

But let me spend a few minutes on the centerpiece to our Pacific strategy, our growing operational platform in Australia. We plan to lift our Australia base seaborne met and thermal sales 15% for 2010 from our existing base. But over the next five years, Peabody plans to double our Australia exports. By 2014, we could produce 35 million to 40 million tons overall, including 12 million to 15 million tons of seaborne met and 15 million to 17 million tons of seaborne thermal coal. Several key projects are under development to deliver this growth.

On the met side, our Denham project would add 3 million to 6 million tons of the finest quality met coal in the world. We also have major expansion plans at three of our existing met operations, which would add another 7 million tons. And for thermal capacity, we could add another 5 million to 7 million tons of seaborne product through expansions at our Wambo Complex, which produces a premium low ash product, and Wilpinjong, one of Australia’s lowest cost mines.

With our growth plans in Australia and our expanded Asian presence, I believe Peabody is uniquely positioned with the best access and highest leverage to these fastest growing markets in the world.

Now, in addition to focusing on the high growth Australasian platform, we have several other priority areas. A major initiative is in place to optimize our production base in the Power River Basin. Here, we are moving equipment and people from the smaller mines to our high BTU, highly productive operations with a goal to expand the margins even as we reduce volumes.

We’ve also established several dedicated teams to pursue cost reduction opportunities at every single operation. While running at full capacity brings economies of scale, we also want to reduce cost on the first ton mined to ensure we maximize margins under any conditions. And as planned, we are consolidating some volumes in the Southwest and Illinois basin in favor of growing production from El Segundo and Bear Run to highly productive low-cost operations underpinned by profitable long-term contracts.

And that brings me to valuation. Simply put, countries and companies investing in coal assets today are re-rating valuations, which are moving significantly upward. Recent transactions suggest Peabody’s Australian operations alone are worth more than our entire market value. And our PRB platform is worth more than half. That’s before factoring in the substantial benefit of our other earnings producing activities in the Illinois Basin, Southwestern U.S., Colorado or our global trading platform. And that’s before considering our industry-leading reserve position or before taking into account our activities in China, Mongolia and our Australian project pipeline. This material gap provides significant opportunity for you to realize growing shareholder value.

So with that, I’ll turn the call over to Mike.

Mike Crews

Well, thank you, Greg and good morning, everyone. We had a great quarter across the platform. Our U.S. operations delivered much lower costs, which expanded our margins. We shipped record met volumes in Australia, brining down our inventory level. Capital spending remains under tight management and our strong sales and working capital improvements drove operating cash flows to a record level, increasing our cash and expanding our liquidity. As I review the quarter in more detail, I’ll generally discuss third quarter performance relative to the second quarter of this year.

Revenues reached $1.7 billion, an increase of 25% over the second quarter due to larger volumes of higher-value Australian met coal, higher U.S. sales volumes, and more than $100 million from trading and brokerage activity. Our third quarter EBITDA reached $341 million on higher contributions from our mining operations.

Let me walk through some of the drivers of EBITDA beginning with the U.S. In the West, our volumes were above second quarter’s due to higher-than-expected deliveries on PRB customer commitments, while Colorado and Southwestern volumes were flat. Our Western revenues per ton were on par with the second quarter, while our costs dropped more than 9%.

We’ve begun to see the benefits of our cost reduction initiatives with lower spending for labor, repairs, and materials and supplies. In fact, each of our Western operating regions turned in lower cost despite suboptimal production levels at some mines. In the Midwest, our revenues per ton rose for the eighth consecutive quarter and costs were up less than 3%, excluding the effects of sales relates taxes, largely due to suboptimal volume. Similar to the Western region, lower repairs and labor costs are mitigating the effects of lower volume. All told, our U.S. margins per ton expanded to 27%, an improvement over both the second quarter and last year.

In Australia, we sold 6.5 million tons, which was more than 30% – which was 30% more than last quarter due to higher demand following the contract settlements. Met volumes reached a quarterly record of 2.7 million tons, nearly tripled the run rate for the first six months of 2009. And our seaborne thermal sales totaled 2.6 million tons, higher than both the first and the second quarter.

Revenues were $82 per ton, approximately one-third more than the second quarter due to a change of mix toward higher-priced met coal including 300,000 tons of carryover business at last year’s higher contracted prices.

Regarding the carryover business, we remain on track to realize approximately $100 million by year-end. Australia’s costs were $66 per ton, reflecting the mixed impact of increased met shipments, a portion of which was the catch-up for lower shipments in the second quarter due to delayed customer settlements. For the full year, we continue to target average costs of $55 to $60 per ton in Australia. The robust performance by our mining operations combined with trading and brokerage contributions drove operating profit to $220 million above the second quarter’s level.

Shifting now to taxes, our tax expense was $57 million for the quarter, including non-cash re-measurement effects on our foreign tax liability. The Australian dollar rose another 8.5% against the U.S. dollar, adding $22 million of expense. As of the re-measurement, our 2009 effective tax rate is expected to be approximately 20%. For the third quarter, our income from continuing operations was $0.41 per share. Excluding the re-measurement effects, it was $0.49 per share.

The combination of strong results, improved working capital, and cash flows from trading operations lead to record operating cash flow of $429 million for the quarter. Our inventory focus was clear with a $75 million decline in Australia driving the overall $88 million decrease.

Our cash on hand at quarter-end was nearly $800 million, further expanding our liquidity to $2.3 billion. Capital expenditures were $79 million for the third quarter and $186 million year-to-date. By controlling spending, we are lowering our full-year CapEx target to nearly 20% to $325 million to $375 million.

Turning now to our outlook, we are raising our financial targets for the year. EBITDA is now expected to be $1.2 billion to $1.3 billion with earnings per share of $1.60 to $1.80 excluding re-measurement effects.

Some of the factors influencing the fourth quarter’s results include two long wall moves, further PRB volume reductions in the U.S. and the timing and mix of Australian shipments. And since the markets have begun to stabilize, we are pleased to offer some early insight into our volume expectations for 2010. In the U.S., 2010 volumes are expected to be 185 million to 195 million tons.

Our PRB sales will be approximately 5 million tons lower than 2009 and 20 million to 25 million tons below our late 2008 peak levels, partially offset by the Southwestern El Segundo mine reaching full production levels and the startup of Bear Run.

In Australia, we are raising our volume targets approximately 15% to serve the growing demand in the Pacific. Our met sales are expected to be 6.5 million to 8 million tons and thermal exports are set to increase to 11.5 million to 12.5 million tons.

And so with that overview of our financials and our 2009 and 2010 prospects, I’ll now turn the call over to Rick.

Rick Navarre

Thanks, Mike and good morning, everyone. I’d like to drill down on several key market trends and discuss how Peabody is positioned to capitalize on them.

I’ll start first with China. We are often asked if we think China’s growing appetite for imports will continue. We believe the answer is clearly yes. We see China’s trend toward greater imports and fewer exports as sustainable for both strategic and practical reasons. In fact, China’s monthly data, just out, indicates that imports were 12 million tons in September, a stronger month than August. In met coal, China’s net imports are approaching 25 million year-to-date versus just 2 million tons last year. That means this year’s net imports from China will represent more than 10% of the entire global seaborne met market.

In addition, China’s government continues to close thousands of unsafe mines and consolidate many smaller operations. This is a big impact on regions such as Shanxi and the Jinan province, which account for much of the country's met coal, including some of the best qualities. This coupled with higher steel demand is why China’s met coal imports have soared. In fact, China has become Peabody’s largest met coal customer in 2009, outpacing India, Japan and other Asian nations.

Regarding thermal coal, China is importing for its coastal plants to keep more of its own coal in the interior where it will be needed. Year-to-date, China’s net thermal imports are up some 50 million tons over 2008 levels. And China’s total net imports of both met and thermal coal is conservatively expected to be up 80 million to 90 million tons by year-end.

India is the other major driver for thermal demand. Even in a global recession, India’s coal generation is up more than 7% and we expect shortages requiring a significant increase in imports in the next several years. The bottom line, when Asia needs more coal, it turns to Australia, the world’s largest exporting nation. And that’s just what China has done. This year, Australia has vaulted into the position of the number one coal provider to China, becoming both the largest thermal and met coal seaborne supplier to the world’s largest coal consuming nation. This obviously benefits Peabody’s Australian platform.

Next, I’ll review the state of the seaborne coal markets. In met coal, you’ll recall last quarter, we still had carryover volumes for coal contracts from last fiscal year. We have now reached agreements to receive full value over time for about 95% of those contracts with a very small remainder awaiting final resolution.

And recent spot met pricing has exceeded $160 per metric ton for Australian hard coking coal. This alone with the rising global economy should have very favorable implications for 2010 negotiations. In fact, we are seeing concern about security of quality met coal supply and it’s clearly growing. We have received commitments from all of our customers in Asia, Europe, and South America for met coal volumes for 2010 and 2011 at or above this year’s volumes.

In the thermal area, we’ve also seen Newcastle prices above the benchmark settlement price of $70 per metric ton. And you need to go out only a few years on the forward curve to see pricing at $100 per ton. Peabody has already layered in some thermal business, exceeding $90 for 2011 delivery and $100 for 2012.

For U.S. investors who may only view exports through the prism of the East Coast suppliers, there are major competitive differences between Australia and Appalachia. Generally, Australia has lower costs, it enjoys better geology, and it has superior met qualities and it holds a significant rail freight advantage of up to $30 to $40 per metric ton.

Unlike some, Peabody also has the ability to accomplish meaningful export growth as a result of strategic investments we have made over the last several years. Greg discussed our substantial Australian growth plans including a 15% increase in 2010 deliveries and a doubling of exports within five years. The next logical question is can we deliver those volumes out of Australia. The answer is yes. In New South Wales, we are the second largest owners of the new 30 million ton NCIG port in Newcastle, which is under construction and will come online in 2010. The second phase of NCIG is in the commitment stage and would come online by 2013 to 2014. And we think that will more than double NCIG’s capacity.

In Queensland, we have additional port capacity, acquired through our 2006 Excel acquisition to help us meet our growth plans for metallurgical coal. Will there be periodic port congestion? Absolutely, anytime we have surging demand, the logistics chain will be challenged. The good news is we expect to have the port in real capacity and congested logistics usually leads to higher prices for those who can deliver.

And I’ll remind you that the last time we had port congestion in Australia, we had record prices and a record year. And despite the current congestion that we are seeing, we are also seeing record shipments. Australia is the only major exporting nation showing growth this year.

Turning from the Pacific markets to the U.S. markets, clearly the sluggish economy and mild summer depressed coal use to an unprecedented degree in 2009 and U.S. coal inventories at utilities are high and will need to come down substantially in 2010. So the best we can say about the past 12 months is that they are now over. However, on the positive side, industrial decline seems to be bottoming out. Winter appears to be coming early and coal and natural gas switching should not be an issue in 2010 based on the 12-month strip for gas, now in the $6 to $7 range.

This reverse alone should boost U.S. coal demand by 30 million to 35 million tons over 2009 levels. And on the supply side, recent coal production statistics show a year-over-year decline of more than 100 million tons on an annualized basis with more reductions, in our view, likely.

As we reported for the past year, Peabody’s U.S. contracting strategy has proven very sound. Peabody is fully committed in price for next year in the U.S., in part because we reduced our planned 2010 production nearly 15 million tons since the beginning of the year.

Our contracting in the United States is far different than Australia where we have 13 million to 15 million tons of met and thermal exports unpriced for 2010. In fact, nearly all of our export production beyond the first quarter of 2010 is available for pricing in what we expect will be very healthy and robust Pacific markets. That’s a view of Peabody’s performance, as well as our market position and our many opportunities.

I’ll now turn it back to Greg for closing comments prior to us taking questions. Greg?

Greg Boyce

Thanks, Rick. So to sum up, we have positioned Peabody for strong performance in all markets and our strategic actions have lead us to very good results. I want to thank all Peabody employees for their great efforts. Peabody has an outstanding balance sheet, great organic growth opportunities to serve the best markets and major valuation upside as the gap closes between asset and equity values.

So with that, we’d be happy now to entertain your questions.

Question-and-Answer Session

Operator

(Operator instructions). And first to the line of Michael Dudas with Jefferies. Please go ahead.

Michael Dudas – Jefferies

Good morning, everybody.

Rick Navarre

Good morning, Michael.

Michael Dudas – Jefferies

First question for whoever wants to take it. In your five-year growth plan, as you illuminated this morning, can you talk a little bit about the lead times, the curve of potential capital decisions and what – any early indication how much it could be to get to those types of levels? What type of growth can you provide off the Australian platform without significant capital needs? And that’s first question.

Greg Boyce

Okay, Mike. Thanks. As we indicated, we expect 15% higher volumes in 2010 over this year. That comes virtually with no growth capital in all. Obviously, we still have our normal sustaining capital in the platform. Beyond that, as we start to grow volumes in ’11 and beyond, we will need capital investments at a number of the projects that we’ve got listed.

And I think that you can assume that the volume growth is going to be back-weighted to that four-year period of time only because of the time frames for permitting and for then construction of some of these projects and it varies. Our metropolitan expansion is already permitted, we are already doing the development work underground, we are finalizing the engineering for the surface changes. So that’s going to be in the near – the early part of that four-year, five-year period of time.

We are doing the final – starting final engineering on our Wilpinjong expansions, but that will need to go through some permitting. And our Denham project as well, which is our big expansion new capacity project, will be in the back part. Burton expansion will be – is permitted, we'll be doing the final engineering on that. That will commit on the early part of the period of time.

Now, in terms of capital, we have not locked down yet final capital estimates on some of these projects as you can imagine or going from feasibility engineering into final engineering over the course of the next year. But suffice to say that we expect all of the capital per ton of capacity to be competitive with all other projects that are going on in Australia.

Michael Dudas – Jefferies

I appreciate that. And my follow-up is, recently the Mongolian government agreed to some taxation, government regulation and participation changes in their mining laws and their government. How comfortable are you with those changes and can you just talk a little bit about potential timing, structure, and the opportunities that Tavan Tolgoi could provide Peabody?

Greg Boyce

Sure. As every – as most folks know, the discussions around the Oyu Tolgoi project, the copper project, have been completed. Those agreements have been signed. So a lot of the underlying hard work has been accomplished in terms of getting a major project across the finish line in terms of negotiations with the government of Mongolia. Obviously, it now has to be built. So the government has now said that they plan on focusing on putting the frame work in place for Tavan Tolgoi to move forward. There are still some unknowns in terms of levels of government participation and how the actual reserve base will be brought to the market, but we do believe that what we are seeing right now are positive signs that we’ll begin to see progress on Tavan Tolgoi moving forward to the marketplace faster than it would have otherwise.

Rick, you’ve been involved with it. Whether there is anything there you want to add?

Rick Navarre

No, I think it’s very positive signs, Mike. I think them getting the Oyu Tolgoi agreement signed, they’ve eliminated the windfall tax over copper, which is one of the major stumbling issues at 68% windfall tax and now, I think they are going to move directly towards trying to address Tavan Tolgoi and Peabody has obviously had a long interest in that project and then we got a great relationship with the government, working towards being a participant in that project.

Michael Dudas – Jefferies

Rick, may be you could remind us the parameters of the potential of what the deposit has and what infrastructure opportunities are needed there?

Rick Navarre

Sure. I mean, yes, obviously there is a – very little infrastructure, but it’s within 150 kilometers or closer to the Chinese border. Its major customer of course is going to be China. It’s going to be a probably predominantly coking coal reserve with some high grade thermal coal coming off of the property as well. It’s a 6 billion ton deposit with large, thick, flat coal seems, not unlike the Power River Basin frankly, probably better reserve – I mean, obviously, higher quality reserves and maybe even thicker seems than what you see in the PRB. So some 60 to 80 meters in total. So big coal reserves, should be low cost and we are looking at it initially, the customer of course will be China.

Michael Dudas – Jefferies

Sure. Thanks, gentlemen.

Greg Boyce

Thanks.

Operator

Next from the line of Paul Forward with Stifel Nicolaus. Please go ahead.

Paul Forward – Stifel Nicolaus

Good morning and congratulations on the quarter. Couple of the numbers that stood out to me in the release were the cost numbers and the – in the Western U.S. and Australia, just wondering if you could talk about the $11.31 cost number in the Western U.S. and whether that’s something that’s – and that was a lot better than we had expected, how sustainable is that number into 2010 and the other side being $65 per ton cost we saw on Australia? Do you see that also as being a number that might hold through 2010 as well?

Mike Crews

Sure. This is Mike. In terms of the Western costs, we were very pleased with the cost reduction initiatives and we were seeing costs come down across the major categories, labor, materials and supplies, repairs, et cetera. And the mix was fairly constant from second quarter to third quarter. So that felt very good.

In terms of looking at the rest of the year, we expect those cost reduction initiatives to continue, there will be some upward pressure on that in the fourth quarter just due to the change in mix because our PRB volumes will be coming down in the fourth quarter.

With respect to the Australia costs at $66, I know that we’ve bounced around here between the second quarter at $37 and this quarter and it all has to do with the mix of the thermal coal and the met coal. So if you recall, at the end of June we had expected to ship another 0.5 million to 1 million of metallurgical coal in the second quarter. Because of the prolonged customer settlement, that did not occur and the costs associated with that coal went on to the balance sheet and inventory. So with a higher mix of thermal coal, that brought the average down.

This quarter, it was the reverse. We had record tonnage at 2.7 million ton and that high-cost coal is coming out of inventory and going into costs. So great from a cash perspective and a throughput perspective, unfavorable impact on costs. That’s part of the reason why we were guiding to a $55 to $60 per ton target for the full year, we were at $50 year-to-date. So this is pretty well in line with our expectation, although with the even higher met volumes, it was slightly higher. But we still continue to target $55 to $66 the full year this year.

Paul Forward – Stifel Nicolaus

And –

Mike Crews

And going into 2010, I mean on a macro basis – from a fuel perspective, based on our hedging program, we should see some benefit from that. On the FX side, we were benefiting pretty well throughout the first part of this year. You’ve seen what the “A” dollar has done against the U.S. dollar. I mean, that could be a $30 billion to $40 billion hit next year. Demurrage has risen somewhat here in later periods. It remains to be seen what happens with Qs in 2010. But ultimately, our costs for 2010 are really going to depend on what our sales and production mix is.

Paul Forward – Stifel Nicolaus

Okay. I appreciate all the detail.

Greg Boyce

Yes, Paul, I might – maybe I just add a bit at a higher level as I indicated in my remarks. I mean, we’ve got a couple of very large teams looking at the underlying cost fundamentals throughout the entire organization and with a particular focus on our operating platform, trying to make sure that we are as cost competitive as we possibly could be and we’ve really started to see the results of those teams fall through to the bottom line in the third quarter of this year.

We expect to see continued results as those programs stay in place through the end of this year and end of the first part of next year. Clearly, our objective is to continue to drive our costs lower with our controllable base such that we can continue to overcome the pressures that we get from the external factors on our costs.

Paul Forward – Stifel Nicolaus

All right. Thanks very much.

Operator

The next question is from the line of Pearce Hammond, Simmons & Company. Please go ahead.

Pearce Hammond – Simmons & Company

Congratulations on a great quarter.

Greg Boyce

Thanks, Pearce.

Pearce Hammond – Simmons & Company

My first question is on Australia met coal volumes. For the full year guidance, is a 6 million to 6.5 million tons and given what you’ve already done this year, which is 4.6 million tons, the implied guidance for Q4 is between 1.4 million and 1.9 million tons. Is there – should we read anything into that or there is just a little bit of a slowdown on the met volumes out of the country?

Rick Navarre

This is Rick. I think we hope to hit the high end of the number of course, which would get us close to 2 million tons of met coal on our record quarter for Q3 of 2.7 million tons. And clearly, Q3 we had a lot of catch-up on the met shipments because of what happened in the first quarter and for second quarter we had stalled settlements.

So I don't think there is anything to read into that. I think we are being a little bit cautious of course with the Qs we are seeing out of Dalrymple Bay. But we should be doing – we can do 2 million tons a year – 2 million tons a quarter rather, and that will put us on pace for the high end of what we are looking for 2010.

Greg Boyce

I mean, the other aspect of that is as we have always indicated, we try and run with sufficient on-the-ground inventories in Australia that we can be very opportunistic when other folks have issues related to production to where they can’t take up their rail or port or we could load vessels out of turn because we have coal available to ship. And the team did a great job from operations through marketing in the third quarter. We watched that on a daily basis. But for planning purposes, obviously, we don't build that into our base forecast. We look to drive that forward on a day-to-day basis where the opportunities may or may not arise and they are very difficult to predict quarter-to-quarter.

Pearce Hammond – Simmons & Company

Thank you. And then my follow-up question is, obviously, everyone is well aware of the permitting issues in the Eastern U.S. driven by the EPA. Are you experiencing any permitting issues in the Illinois basin, are you seeing a potential shift there where you could see the EPA get more focused in the Illinois basin?

Greg Boyce

I would say the only thing that we are seeing right now in the Illinois basin is we are seeing a delayed permitting time as we go through some of our new permits. The public process has a little more making sure the I’s are dotted and the T’s are crossed shall we say? We haven't seen any fundamental change in being able to get the permits. We have actually built in just a little more time in order to accomplish those permits ahead of when we expect the production to take place. But we have seen nothing that looks like what’s occurring in the East start to occur in the Illinois basin.

Pearce Hammond – Simmons & Company

Thank you very much.

Operator

And next with the line of Brian Singer with Goldman Sachs. Please go ahead.

Brian Singer – Goldman Sachs

Thanks. Actually, a follow-up on the previous question with regards to met volumes in Australia, really more focusing on 2010. I think if we look at the last nine quarters or so, you’ve had met shipments of 2.4 million tons or higher for, I think, four of them. As you mentioned in your 2010 guidance, top of the range assumes about 2 million tons a quarter. I'm sure there are maintenance long wall moves, et cetera. But if China demand stays strong, other markets rebound, and you have more port capacity, what would prevent you from selling at least 2 million or more per quarter?

Greg Boyce

I think our forecast, as I said, is clearly at on average 2 million tons per quarter. I think the limiting factors, of course, are going to be port constraints with respect to – we have the capacity. The question is can we move it all with the queue system that’s in place right now. We think that we are doing certainly better than others and we think the queue system is, while it’s tight, they are still shipping at record levels. If the China demand continues, which we think it will, there’s opportunities for us to increase that number. But right now if we are giving guidance this early for 2010, I think we want to stick with what we are at on the 6.5 million to 8 million tons and if we see some better opportunities down the road, we’ll certainly keep you posted.

Brian Singer – Goldman Sachs

Great, thanks. And then as a follow-up, switching to the U.S., can you just provide some color from what your utility customers are seeing in terms of their own willingness to contract and maybe some updated view on – of the sharp reduction we’ve seen in thermal coal demand, how much you think is related to weather versus coal to gas substitution versus more secular economic factors?

Rick Navarre

Clearly, we’ve obviously had – 2009 has been a tough year because generation has been down. We expect coal generation, electricity-fired coal generation will probably be down about 100 million tons roughly on an equivalent basis before we get to the end of the year.

And so that’s had an impact and of course, since the last time we talked to you, gas prices were very, very low during this last quarter as well as we really didn’t have much of a summer. So that has, of course, built inventories in stock piles at the customers which I talked about in my remarks.

But as we look forward to 2010, it will be a year of stock piles hopefully being reduced by the customers. From our standpoint, we – from our analytic standpoint, we looked ahead and we basically made sure that we were committed and we don't really have much to sell. And frankly, we are sold out the year and we reduced our production in the PRB accordingly to the right levels and we are going to manage through 2010 and continue to grow what we have in the international platform and as we look forward to 2011, we have a lot of coal to still sell in those out years and we are looking for the market to be much stronger.

Brian Singer – Goldman Sachs

Great, thank you.

Operator

And we’ll go to Jim Rollyson with Raymond James. Please go ahead.

Jim Rollyson – Raymond James

Good morning, everyone. Great quarter and great overview. Rick, you spent time kind of in detail talking about – as well as Greg, about the growth plans in Australia and kind of the port capacity plans that are on the works, that you guys have been working out for a while. You kind of grossed over a little bit just the rail side. Can you give us an update on maybe what you see for rail capacity and how that fits into the growth in the port capacity?

Rick Navarre

Well, clearly, obviously the logistics chain is limited by its weakest link and right now, I think if you look at – in Queensland, the weakest link is going to be the rail capacity. Just finished the final – the third stage of Dalrymple Bay that gives it a theoretical 85 million ton a year capacity, finished that in June of '09. Now, we need some – the rail system is not up to that capacity. We are running at about 50 million tons this year on average, but we have seen months that have been actually higher than 85 million tons on a run rate.

What we do know is of course that there is a lot of investment going on in Queensland by the Queensland Rail System. They are putting in additional capacity, additional works that will – they are adding this $500 million Jill Allen project, which will increase, when it’s finished, the actual rail loadings from 29 cars a day to almost 42 cars a day, which will be taking up from 100 million to 130 million tons. So we are seeing it coming online. Hopefully, that will happen sometime in mid to late 2010, which will allow us to increase the throughput out of Queensland.

We have ourselves, as you may have seen in some of our recent announcements, committed additional capacity signed up for agreements both in New South Wales and are working on agreements in Queensland as well. So we will have the benefit of rail capacity and we believe we have a good balance between rail and port capacity so that we can achieve our growth goals.

Jim Rollyson – Raymond James

Thanks, that’s very helpful. And as a follow-up, you guys have obviously seen a little bit of pickup quarter-over-quarter on the trading side of your business and obviously, expanding offices to new locations to take advantage of the business opportunities. Any thoughts kind of going forward, 4Q and really looking into next year with what you see going on in the Pacific Rim on how you think about the trading opportunities?

Rick Navarre

Well, obviously we see that it’s a great asset for our business that gives us incredible insight into the market, allowing us to make investment decisions and make the right calls in the market we hope and that’s why we are continuing to expand because we see the market really being so connected with what’s happened in Asia and you see us growing in a lot of the performance growth that we've had in trading and brokerage in the last year, while we’ve seen a decline maybe in liquidity with some of the participants, our international platform has grown.

We continue to grow in both Europe, we’ve grown in Asia, our China platform has had a good year with what’s going on in China and we hope to expand that to Indonesia and India as well with the opening of the Singapore office and the Jakarta office. So good things to come, it’s difficult to predict when you are starting with a blank book with where we are at. But I wouldn't predict the quarter Q4 as high as Q3, but certainly we’d look towards 2010 and we haven't given guidance yet, but certainly our goal would be to be able to have similar results and as a percentage of our total EBITDA.

Jim Rollyson – Raymond James

Very good. Thank you.

Operator

And next from the line of Kuni Chen with Bank of America-Merrill Lynch. Please go ahead.

Kuni Chen – Bank of America-Merrill Lynch

Hi, good day, everybody.

Rick Navarre

Good morning.

Kuni Chen – Bank of America-Merrill Lynch

I guess just first up on China, I mean some of your comments suggest that the – there is structural changes there and the net import position should continue going forward. Just on the safety side of the equation, what do you see going on there? Does that start to alleviate going forward and potentially there is more domestic production to come back online as that gets easier?

Greg Boyce

I think there is a couple of issues that are happening in China. First, on the – on this – which affects structurally where they're at relative imports to exports. On the safety side, we see that as a long-term trend. I mean, they have just got thousands of these small mines and as they continue this push of closing and consolidating these smaller mines, there is a certain balance between how many large mines they bring iron to offset all of that lost production versus what they target long term for a level of imports.

And as we look at what their – what China and Chinese companies are doing relative to looking at assets and operations and reserves outside of China, it’s clear to us that they have a two-pronged strategy to meet their needs. Their internal strategy is to close the unsafe mines and build larger mines, but not to make up their entire requirements. The rest of their requirements, they are going to import from outside of China to balance their demand and for both met coal where they are structurally short and thermal coal where they have got a higher demand in Southern China than they do up in Northern China.

Rick Navarre

And I think it’s a consistent question that we receive and you go back six years, they were 80 million tons net exporter and every year they were coming down and the reasons were safety and because of security of supply at home. And the questions always were will China reverse that trend. And we’ve always said, “We don't think so,” because what we see in China is that they are very serious about safety, they are very serious about their resources and their security of supply and there is no reason for them to turn it around and go back the other direction.

Kuni Chen – Bank of America-Merrill Lynch

Okay. And then as a follow-up just on Australia, some questions earlier there on the CapEx project pipeline. Can you just talk broadly about your views on whether it’s a more attractive return on capital to build or to buy assets?

Greg Boyce

Well, we’ve got to focus on doing both. I mean, you can’t guarantee success in terms of buying assets where we've got high return, good organic growth opportunities in our existing platform. We are pursuing those to meet the market demands, but we have the financial capacity to both and to the extent that we are able to shake loose and do some acquisitions, we plan on doing that as well.

Kuni Chen – Bank of America-Merrill Lynch

Great, thanks. Good luck.

Operator

And next from the line of Mark Caruso with Millennium Partners. Please go ahead.

Mark Caruso – Millennium Partners

Hi, good morning. I just had a quick clarification on two things. Rick, you mentioned earlier talking about 2010 and 2011, conversations with customers. Was that on volumes and pricing and are you guys going to be able to potentially book tons earlier or was that just preliminary discussions?

Rick Navarre

No, I mean our discussions with customers have been that clearly we are not in the market selling 2010 business where we can’t get a – where we think we can get a reasonable return. So we are – basically, as I said, we are sold out, we reduced our production. So we are really not having a lot of discussions about 2010 business with customers at this point in time. If the markets change, inventories correct themselves quickly, we’ll talk about it.

As it relates to 2011, there may be – we are not really a big seller at today’s spot prices for 2011 either. And so we are waiting the – 2012, the curb is very steep and we are seeing a better contango in all of the markets when you get out to ’11 and ’12, but – so we will just see how it goes. We are in no hurry to making those decisions at this point in time.

Mark Caruso – Millennium Partners

Okay. And then just a follow-up on the met side. You guys mentioned in the release 1.7 million tons from your Australian operations. Is that – sounded like that could be sustainable beyond trading on a more long-term basis and are there any indications of a sense of urgency for 2010 on the met side?

Rick Navarre

I’m not sure I followed that. The 1.7 million tons of met coal to China?

Mark Caruso – Millennium Partners

Yes. You guys are saying that you did 1.7 million tons out of the Australian operation. So I would like to see that rather than just in trading. So I’m wondering one, is that sustainable? And two, given that you’ve shipped that much out of the Australian operations in '09, are you seeing a sense of concern or urgency for customers for met for 2010?

Rick Navarre

Absolutely. I mean, we are actually – our customers are concerned about supply. We are not – I will guarantee you that. That’s why we – as I mentioned in my remarks, many of our traditional customers have come back to us and wanting to confirm and they actually have that volume available to them knowing that they didn’t take as much as they – this year as they did last year and that we sold a lot of coal to China and they want to make sure that somebody else doesn't get that volume from them. So it’s – I think that’s going to create a lot of tension in the market going forward.

Mark Caruso – Millennium Partners

Thanks.

Operator

And we go to the line of David Conti [ph] with FBR Capital Markets. Please go ahead.

David Conti – FBR Capital Markets

Yes. Hi guys, great quarter. In trying to prepare for sort of the surprise that can come out on us, we from a Washington policy side climate, can you give us sort of an update from what you are seeing from your side?

Greg Boyce

Well, I think we are seeing the same thing everybody else is seeing and that’s right now Washington is focused on so many big issues that they are having a hard time getting any of them to the finish line. Everything we are hearing is health care is job number one in Washington and still has a long way to go. There is a lot of committees that are coming out with their climate proposals, but we haven't seen one yet that seems to have the components that people will start to coalesce around.

So our expectations is there is going to be a lot of discussion but it’s not going to be this year event in all likelihood given the complexity of the issue and given the fact that health care has to go first. And I think that’s positive because I think given where the economy is today, there is more and more people, as we do discuss the climate issues, are looking for practical solutions that allow economies to grow, whether it’s here or outside of the U.S. and that will mean we’ll have a better outcome at the end of the day.

David Conti – FBR Capital Markets

Great. And on the positive side, obviously you guys do a very good job of tracking the global picture here. Given with the disruption in the marketplace with the global economy, can you give us a sense of how much coal-fired capacity you think will get built – pick your time period that you guys feel comfortable in putting a number out there, 2012 or so incremental coal-fired capacity?

Greg Boyce

Outside of the U.S.?

David Conti – FBR Capital Markets

Yes, that’s fine. Outside of the U.S. is fine, yes.

Rick Navarre

Yes, that number easily could be 100 gigawatts or so over the next three years and the total number that’s under construction is 180 gigawatts. That’s about 700 million tons of coal supply that’s needed and if it’s under construction, it’s going to come on within a five-year time period.

Greg Boyce

And clearly, the vast majority of that is China and India based.

David Conti – FBR Capital Markets

Right. Have you seen a material slowdown in the pace of the new fire – coal fired built in China or in India?

Greg Boyce

No, we have not seen any material slowdown in either one of those countries. They continue to be the major drivers of coal demand. As we look at that – the Pacific Rim markets growing in excess of 7% to 8% compounded annual growth rate, China and India are the main drivers of the demand growth for the Pacific Rim. I mean, that doesn't diminish the other countries in the Pacific Rim, but they are the ones that are building most extensively and have continued to do so.

Rick Navarre

And in fact, as the recession has eased, you’ve seen South Africa again talk about shortages, Indonesia again talk about their generation needs domestically, India has obviously got a major build-out going.

David Conti – FBR Capital Markets

So the last question I want to ask tied to that is what do we – what is Peabody – obviously the Australian position and some of your other international positions are benefiting, but how – what are you seeing from the U.S. side on your exports this year as you start exit into next year? Are you starting to see some pull on your volumes abroad?

Rick Navarre

Dave, this is Rick. Actually this year we've actually probably contrary to what has happened in the rest of the market out of the U.S., we’ve actually had an increase in export business out of our – most of that’s coming from the trading platform of course from the position that we’ve been able to secure and lock in utilizing the API contracts.

So -- but – so we think it’s a – we continue to be opportunistically we’ve been able to lay in some export business. As we look out forward from the U.S., we see frankly longer-term the PRB is going to be a player in the export market, particularly to the Asian market because there is not going to be enough coal. I mean, as Greg mentioned, we think that the fundamental shortage in the global demand and it’s going to be in Asian markets and it’s not going to come from the East Coast of the United States.

David Conti – FBR Capital Markets

There was a talk about a port – an additional port on the West Coast. Is that something that still, you think, in the works?

Greg Boyce

Yes, I think – yes, as we talked before, there is a significant amount of work going on by a number of parties looking at West Coast of North America locations for large-scale port capacity, particularly for the Powder River Basin coals to be able to make it into that Pacific seaborne market on a direct West Coast access. So I think there is more to come on that. It’s early days, but I can tell you, there is a significant amount of activity happening in terms of people looking at what the options are.

Operator

Our next question is from John Bridges with JPMorgan. Please go ahead.

John Bridges – JPMorgan

Hi, good morning Greg, Rick, everybody.

Greg Boyce

Good morning, John.

Rick Navarre

Good morning, John.

John Bridges – JPMorgan

You mentioned a pullback in PRB production in the fourth quarter. Would it be correct to assume that the bulk of the reduction, as per your guidance, would come from the PRB?

Rick Navarre

Yes, that’s correct, John. Most of the production in our – is coming out of the Powder River Basin. We got some minor reductions at some other locations, but the vast majority of that is on the PRB.

Greg Boyce

We do have a long wall move at Colorado, which will impact our Colorado volumes, but absent that, most of it would be out of the Powder River Basin.

John Bridges – JPMorgan

Okay, great. Could you say a little bit more about the exports – the export opportunities? How you see that developing?

Rick Navarre

Sure. I mean, there are still going to be opportunities from the East Coast as – they are not there today, John, because the prices are too low. But as you look forward on the price curve, when you see the contango and as I said earlier, we've been able to lock in business at $100 a ton for 2012 as we see that market develop there and you can use the financial instruments to be able to secure the sale. You can do export business at $100 a ton and make a margin and make some money.

As it goes to the West Coast and we think that ultimately over time, there is going to be a place for PRB coal in Asia because there is not going to be enough coal because of the demands of the low – the current exporters out there, Indonesia and others are going to be keeping more coal at home to meet their own growing demand.

So – and – we are seeing a lot of interest from the Asian countries around Powder River Basin coal and it’s just a matter of being able to get the build-out and get the prices right and get it – and move it.

John Bridges – JPMorgan

And then just as a follow-up, as you are discussing the situation with the Mongolian coal, how do you ensure competitive pricing on that if your customers are predominantly China and you have difficulty getting it outside that market?

Greg Boyce

You obviously have to pick the right pricing mechanisms when you do your agreements. I mean, that’s something that obviously we’ll have discussions if we are moving to those phases with the Mongolian government, as well as the folks – any of the customer base in China.

Operator

The next question is from the line of Shneur Gershuni with UBS. Please go ahead.

Shneur Gershuni – UBS

Hi, good morning, guys.

Greg Boyce

Good morning.

Rick Navarre

Good morning.

Shneur Gershuni – UBS

I was wondering if I can follow-up on some of the questions with respect to the cost in Australia and so forth. I think Michael had mentioned that there was mixed shift and so forth and I kind of want to get a sense of how to think for 2010 and I was wondering if you can sort of give a breakdown of what percentages related to the fact that royalties are part of the equations.

Rick Navarre

The royalties as they relate to 2010?

Shneur Gershuni – UBS

In general. Are you paying 20% royalties, 18% royalties? I mean, because obviously it you ship (inaudible) which is a higher priced product, I'm trying to get a sense of what your royalty rates were in Australia.

Rick Navarre

Yes, the royalty rates typically are in the 7% to 10% range. There would be – you would see a decline come down with lower average sales prices potentially. I guess there is one open issue in New South Wales though in terms of just the way it’s calculated. We today can exclude our port and rail costs from that calculation for applying the royalty and there are some discussions whether or not that may come out of the calculation.

Shneur Gershuni – UBS

But otherwise, absent any change in the Aussie dollar at this point right now, the cost performance this quarter should be what we should be thinking about for 2011?

Rick Navarre

No.

Greg Boyce

2010.

Rick Navarre

I mean –

Shneur Gershuni – UBS

I’m sorry, for 2010. 2010.

Rick Navarre

The cost performance in the third quarter for Australia is the high watermark for the year, okay? So, we’ll come down in the fourth quarter and that will get us back into this range of $55 to $60 a ton. As we got into 2010, I mentioned some of the factors that are going to affect that, but it’s too early I think for us to give guidance, although we are clearly trying to limit that and it looks like we should be close to being in line in 2010.

Greg Boyce

Yes, I think one way to look at is, as we have indicated that we thought for the year would be in that $55, $60 a ton range. That was based on that mix of met coal and thermal coal and domestic supply versus export supply that we had in our forecast, which is probably kind of what you would see as we look into the fourth quarter of this year.

What happened in the second quarter is we had much higher thermal coal and a higher domestic component drove our costs down, lower than that average. What you saw on the third quarter is record met coal, lower thermal coal that drove our average higher to above that $55 to $60 range.

So as you look forward into next year, absent any exchange rate formulas, absent any changes in the royalty rates out of New South Wales, we are going to be right into that $55 to $60 range. We don't see anything from an operating perspective that’s going to put undue cost pressure in 2010 on that average mix of thermal and met coal.

Operator

And we have a question from the line of Meredith Bandy with BMO Capital Markets. Please go ahead.

Meredith Bandy – BMO Capital Markets

Hi guys, great quarter. Thank you for all those guidance on the call as well. You guys mentioned in your remarks, obviously you have a lot of liquidity and then you’ve raised you EBITDA for 2009, which is sort of trough year. How are you going about thinking in terms of your CapEx projects, in terms of where you share prices, where your dividends are, and in terms of any M&A opportunities in this market? How – what are your use of the cash, what are your priorities?

Greg Boyce

Well, we have always said our priority first and foremost is to continue to grow the business when good, strong opportunities exist, whether that’s a capital to fund our organic growth platforms either with our opportunities in the U.S. like Bear Run and El Segundo or now our Australian growth platform that we are – we've been talking about this morning. We have continued to be acquisitive and we would look for and continue to evaluate opportunities to expand the platform through acquisition.

You get beyond those, then we continue to evaluate what our capital structure is, which we are comfortable with our capital structure today, but – and also what our dividend programs are. So all of that is in the mix as we look at uses of cash going forward. But I would say, first and foremost we put a premium on where the opportunities exist to grow the business.

Meredith Bandy – BMO Capital Markets

Okay. And then if could just ask a follow-up on – obviously, M&A is a priority and in the past you guys have talked about M&A more focused on the growth regions, which would obviously be Asia-Pacific. Today, you’ve mentioned Mongolia quite a bit. Do you have any thoughts that you would be willing to share with us on Tavan Tolgoi and if the Oyu Tolgoi agreement has changed your thoughts on Tavan Tolgoi at all?

Greg Boyce

Well, we are – as our comments this morning have indicated, I mean we still believe that Mongolia will play a role in supplying the largest coal market in the world, which would be China in the future. We made acquisitions in Mongolia when we formed our Peabody-Polo joint venture earlier this year. We continue to do a significant amount of drilling on those exploration licenses in the South Gobi and other parts of Mongolia.

And to the extent that we are successful, we would like to play a role in Tavan Tolgoi, but the government is still working on putting that package together, issuing it to the market for submittal and then we'll have to see how successful we are. But we think we have positioned ourselves because of our operating platform in Mongolia now and the work that we’ve done there very positively. But we do at a high level feel positive about Mongolia being a supply source for China over the long term.

Meredith Bandy – BMO Capital Markets

Okay, thank you very much.

Operator

And ladies and gentlemen, we have time for one more question. That will be from the line of Jeremy Sussman with Brean Murray. Please go ahead.

Jeremy Sussman – Brean Murray

Hi, good morning. Congratulations.

Greg Boyce

Good morning, Jeremy.

Jeremy Sussman – Brean Murray

Sure. You said that you layered in some, if I heard you correctly, some thermal – export thermal business out of Australia for $90 a ton in 2011 and $100 in 2012. Clearly, nothing is happening in the U.S. Can you talk about how Asian buyers I guess on the thermal side are looking at coal? I mean, what type of volume are we talking about?

Rick Navarre

We did – you are correct, we did lock in some volumes for ’11 and ’12 at $90 and $100. And really the volumes are open – are up to us to some extent right now. The market is open and that’s the price that’s out there right now today in the market. It’s in the financial markets, but you can basically sell forward in the financial markets and go ahead and lock in and hedge your book basically.

So you basically guarantee those prices for the sales. So it’s really – you are not having to have contract essentially with a physical buyer at this point in time, you’ll do that later when you close out the position.

Jeremy Sussman – Brean Murray

Okay, understood.

Rick Navarre

Choosing our trading book and then if you look at the trading markets in the API 4s and API 2s, that’s what the trading price is.

Jeremy Sussman – Brean Murray

Okay, great. And then just one quick follow-up. You talked about how China imported 12 million tons in September. You just – do you have a breakdown of met versus thermal and then in the fourth quarter I guess where do you see this playing out both overall numbers and then for what you specifically, Peabody, can do?

Greg Boyce

Well, we had the numbers pretty tight through August, Jeremy and this morning the new data came out and it really just showed the total net number, it was 12 million tons. I guess if we had to make an estimate, we’d probably say 5 million tons of that might have been met and the rest of that would have been thermal. It’s probably our best guess about spread, but we’ll have better information on that later as we move down the road, but we had the information through August pretty tight. But as we look for the fourth quarter, we’ve kind of suggested that we are seeing here today at a net 69 million ton exported out of Australia.

We think that number could probably go to 80 to 90 after what we heard today and saw 12 million tons, a pretty strong September. 80 to 90 would essentially be an 80 plus million ton growth over last year. Of course, we are very active in selling into that market and we have both as you said, we try to sell the physical platform and we also sell out of the traded platform into that market. So we expect to continue to participate and you can see from our traded numbers that we've had some good success in selling some of the trading coal into China.

Jeremy Sussman – Brean Murray

Great. Well, thank you for all the color.

Greg Boyce

Thanks.

Operator

And I’ll turn it back to you, Mr. Boyce, for any closing comments.

Greg Boyce

Well, I want to thank everybody for your interest in Peabody and as you can tell, we are very pleased with the quarter that we’ve just completed. As you look at what’s happening globally, particularly with the seaborne markets, we see strong, strong demand returning. We have said in the past, given the under-investment globally over the last year in the energy markets and particularly in coal that we were going to see a strong return to pre-recession levels. I think we are starting to see the early indications of that and look forward to continuing to talk about our – particularly our global platform as we move forward.

So thank you very much.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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Source: Peabody Energy Corporation Q3 2009 Earnings Call Transcript
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