Investors in Peabody (BTU) reacted with slight enthusiasm to last week's comments on the company's full year results for 2013. The company is stuck with a leveraged balance sheet amidst very low coal prices, leaving the company and its investors "stuck" for now.
While a cyclical upswing could unleash a great deal of value for shareholders given the operating leverage of the firm, on top of the financial leverage, investors should be careful when and how meaningful a coal price recovery really could occur.
Comments On 2013
Peabody updated its full year outlook for 2013, indicating that full year EBITDA is seen $60-$80 million lower than previously anticipated.
Lower profitability came on the back of a delay in the commissioning of a new coal caving system at Peabody's Goonyella mine, combined with a resolved labor action at the Metropolitan Mine.
Peabody had only partially foreseen these issues back in October, but these issues are larger than previously anticipated. Mine teams are now working at the Goonyella mine, while the new labor agreement at the Metropolitan Mine has been signed, with workers resuming operations.
Peabody furthermore noted that full year adjusted EBITDA for 2013 excludes the settlement with Patriot Coal as well as the United Mine Workers of America. This can result in charges to both continuing and discontinued operations.
Peabody Energy ended the third quarter with $551.3 million in cash and equivalents. Total debt stands at $6.01 billion, resulting in a net debt position approaching $5.5 billion.
Revenues for the first three quarters of the year came in at $5.27 billion, which is down 13% compared to a year earlier. Earnings plunged, falling from $420 million in the comparable period last year to just $41 million this year.
At this pace annual revenues are seen around $7 billion while adjusted EBITDA is now seen around $1.03 billion, as adjusted earnings are seen at $0.36 per share.
Trading around $18 per share, the market values Peabody at $4.9 billion. Therefore equity in the business is valued at 0.7 times annual revenues, 4.8 times adjusted EBITDA and roughly 50 times adjusted earnings.
Despite the suboptimal earnings and high debt position, Peabody still pays a quarterly dividend of $0.09 per share, for an annual dividend yield of 1.8%.
Some Historical Perspective
Long-term investors in Peabody have seen a whole lot of volatility but no real returns. Shares peaked in their eighties in 2008 to end that year below $20 per share. Shares have recovered to highs of $70 in 2011, but leverage concerns and poor coal demand sent shares to just $15 in the summer of this year.
Despite a recovery to $18 per share at the moment, shares are still trading with losses of over 30% so far this year. Despite the poor operating conditions, Peabody managed to increase its annual revenues by nearly 40% to $8.1 billion. After reporting solid earnings in previous years, Peabody reported losses over the past two years.
Back in November, Peabody presented itself on a Goldman Sachs (GS) conference. The company notes that it is well-positioned to benefit from the upswing in coal demand as prices have stabilized and saw a slight recovery from the lows of the summer of this year. This came on the back of supply rationalization seen across the globe.
For the long term the company sees further growth with an estimated 1.2 billion tons in global demand for coal by 2017, driven by growth in China and India. According to Peabody, China is expected to make up 40% of worldwide demand in four year's time.
Tackling concerns about the environmental impact of coal on society, which is especially a big issue in big Chinese cities with the smog issues, Peabody points out that coal has seen growth while environmental pressure has been on he decline. For example, Peabody notes that US demand for coal increased by 170% since 1970, while emissions per Megawatt fell by 87% in the meantime. This came on the back of the closure of older plans, emission controls and the usage of coal-to-gas facilities.
To combat the poor pricing, Peabody has been lowering its production costs, selling assets and slashing capital expenditures. The capital investment budget for 2013 is seen down nearly 70% compared to last year, seen between $350 and $400 million per annum.
While Peabody obviously cannot help the poor market conditions, its $5 billion acquisition of Macarthur in 2011 is very poorly timed in hindsight, being responsible for the entire net debt position which the firm carries at the moment. Luckily for shareholders, the cut back in usage of nuclear power notably in Japan and Germany provided a boost in demand in a still very difficult operating environment.
As such, Peabody is taking all the right steps providing very strong operating leverage once prices recover, as costs and production are not the company's biggest problem at the moment. Still such a cyclical upswing might be difficult to predict, especially amidst greater energy efficiency, relative cheap natural gas prices and the continued growth of renewable sources of energy.
While other energy sources might have better very long-term growth prospects, coal will be a dominant energy source for decades to come. The marginal cost of production of energy will however determine its importance in this future energy market and determine the very long-term prospects of firms like Peabody.
I conclude that Peabody remains well positioned for a rebound in the global coal market, yet it remains a question when this will materialize and to which degree. In the meantime, investors need to be prepared for a rough ride given the significant operating and financial leverage being employed by the firm.