Peabody: Better Thermal Coal Prospects, But Met Coal Market Remains Challenging

| About: Peabody Energy (BTUUQ)


Peabody's revenue from its U.S. operations expected to drop this year due to price opener provisions in some of its long-term contracts.

Oversupply of met coal is expected to remain this year as well, which will keep met coal prices down. Lower prices will negatively impact the company's Australian operations revenue.

In Australia, Peabody is facing headwinds on the cost side also due to longwall commissioning getting delayed at the North Goonyella Mine well beyond the originally anticipated time.

Peabody Energy (BTU) is planning to increase its thermal coal production this year to meet the growing demand for coal among U.S. thermal power plants because of rise in natural gas prices. The company's operation cost per ton is also expected to decline this year due to improvement in productivity. However, there are various factors which may constrain its margin in both the U.S. as well as Australian operations, which will keep EPS low this quarter.

Constrained margins in the domestic thermal market

In the U.S., thermal coal demand is increasing among utilities due to the rise in natural gas prices. In 2014 and 2015, the natural gas spot price is expected to remain about $4.17 per million British thermal units (MMBtu) and $4.11 MMBtu respectively, which was around $3.76 per MMBtu in 2013 and $2.77 per MMBtu in 2012.

The following is the natural gas price range at which buying coal from different U.S. basins will be competitive to natural gas for thermal power generators:

U.S. Coal Basins

Competitive natural gas price per MMBtu range

Powder River Basin (PRB)

$2.5 to $2.75

Illinois Basin

$3.25 to $3.50

Appalachian Basin

$4.5 to $4.75

At the forecasted prices, it is more profitable for thermal power plants to use coal from PRB and the Illinois Basin due to their lower price in comparison to natural gas. Peabody Energy has forecasted that by 2016 combined demand of coal from these two basins will increase by 100 million tons. Due to the increase in demand, the price of coal from these basins is expected to increase. PRB's coal price is about 40% higher this year compared to 2013, and it is expected to increase further in the coming quarters.

Factors affecting Peabody's margins

Increasing production: Thermal power plants buying more coal will positively impact Peabody's sales as they account for 73% of the company's total sales volume and the company's primary operations in these two basins. Last year the company sold about 158.8 million tons of coal from PRB, Southwest and Colorado mining operations, and 26.3 million tons of coal from the Illinois Basin. With the expected increase in demand, this year it is targeting to produce about 185 million tons to 195 million tons.

Improving cost: Last year, Peabody's U.S. operations cost per ton declined 3% from 2012 due to a 9% improvement in productivity. This year it is expecting its cost per ton will reduce by 1% to 3%. The cost reduction will help Peabody improve its margin.

Revenue will drop this year: The company is expecting revenue to drop 5% to 8% this year mainly due to price reopener provisions in some of the company's long-term contracts, primarily from the Illinois basin. However, the company's long term prospects are expected to increase in the coming years, as demand and price of coal from the company's operating regions increases.

Met coal operations will remain affected

Peabody's Australian operations, which contribute about 40% of the company's revenue base, are facing headwinds, especially in the met coal market. In the past few years, global miners like BHP Mitsubishi Alliance (NYSE:BMA) and Glencore Xstrata (OTCPK:GLCNF) increased their met coal production to improve their cash cost per ton, and supply is expected to increase further. BMA's met coal production increased by 22 million tons last year, and it is expected to increase an additional 6 million tons this year. Glencore's met coal production for 2013 was 7.3 million metric tons, up 6% over 2012. Due to the increase in production by these miners, the met coal supply increased by about 8.5 million metric tons, or 3% more than the global demand. With increasing supply, analysts are expecting the average price of met coal to remain around $154 per metric ton this year, which is similar to $153.41 per metric ton. However, it is significantly lower than 2012's average price of $210 per metric ton.

Global oversupply forcing the met coal price down is already impacting Peabody's revenue negatively, and the company is facing issues keeping its cost down. It has delayed the on-going longwall commissioning at the North Goonyella Mine in Australia, where the company produces high grade met coal. The company is facing a number of start-up challenges related to hydraulic, mechanical and electrical equipment, which has delayed commissioning well beyond the originally anticipated time. The company was also facing labor issues in another met coal producing mine in Australia, named Metropolitan Mine. There was disagreement between the mine's laborers and Peabody concerning the terms of enterprise work agreements, which led to strikes and other industrial actions for six months, which ended in November last year.

Due to these two issues, Peabody's cost per ton increased by approximately $5 in the fourth quarter of last year. Although labor issues at the Metropolitan Mine have been resolved, the longwall commissioning delays still remain a concern, and it is not able to produce at full mining capacity, which is 5 million metric tons. The company is expecting to sort out technical issues by the second quarter of this year from current production of 2.3 million tons.

Due to the longwall commission delay at the North Goonyella Mine, the company is expecting cost per ton from its Australian operations this year to be around the low to mid $70 mark per ton of coal in comparison to $74.18 per ton in 2013. With the price expected to remain low like last year and similar cost structure, the company's Australian operations will continue facing challenges.


Peabody's U.S. and Australian operations' revenue is expected to be negatively impacted by factors like contract reopeners in the Illinois Basin, low met coal prices and operational delays. The company has estimated that its first quarter EPS will remain in the range of ($0.01) to $0.14. The company's U.S. operations position is expected to improve in later years. In the current situation I recommend investors hold their position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.