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Peabody Energy (NYSE:BTU)

Q2 2010 Earnings Call

July 20, 2010 11:00 a.m. EST

Executives

Vic Svec - SVP, Investor Relations and Corporate Communications

Gregory Boyce - CEO

Michael Crews - CFO

Rick Navarre - President and Chief Commercial Officer

Analysts

Pearce Hammond - Simmons & Company

Brian Singer - Goldman Sachs

Jeremy Sussman - Brean Murray

Mark Liinamaa - Morgan Stanley

David Khani – FBR Capital Markets

Paul Forward - Stifel, Nicolaus

Kuni Chen - Bank of America Merill Lynch

David Gagliano - Credit Suisse

Curt Woodworth - Macquarie

Michael Dudas - Jefferies & Company

Shneur Gershuni - UBS

Garrett Nelson - Davenport & Company

John Bridges - J.P Morgan

James Rollyson - Raymond James & Associates

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Peabody Energy second quarter earnings release conference call, at this time all participants are in a listen only mode and later we will conduct a question-and-answer session, with instructions being given at that time. (Operator instructions) As a reminder this conference is being recorded, and now I would like to turn the conference over to your host Mr. Vic Svec. Please go ahead Sir.

Vic Svec

Okay, thank you, and good morning every one. Thanks very much for taking part in the conference call for BTU. And with us today are our Chairman and CEO, Greg Boyce, Executive Vice President and CFO, Michael Crews, as well as President and Chief Commercial Officer, Rick Navarre. We will make some forward looking statements today and they should be considered along with the risk factors that we note at the end of our release, as well as the MD&A section of our file documents. And we also refer you to peabodyenergy.com for additional information. With that I’ll turn the call over to Greg.

Gregory Boyce

Thanks, Vic, and good morning everyone. It’s clear that Peabody had another outstanding quarter on the strength of our U.S. and Australian mining platforms with our underlying cost control and strong top line lift. In addition, I would say our financial position is better than ever. It is also apparent to me that we are just beginning to reap the benefits from our portfolio optimization programs and the long-term cycle for coal. Our operating initiatives are yielding results, both the U.S. and International markets have much more upside and we have the leverage to rising volumes and pricing as we capitalize on the fastest growing coal markets.

Let’s take a moment to review the coal fundamentals and our position in these markets. In the Asia Pacific region, we have seen a two pronged growth driver in the first half, led by China’s appetite for energy and particularly coal imports, as well as recovering generation in steel production in the developed economies such as Japan, Korea, and Taiwan. Peabody expects specific thermo-coal inputs to rise more than 10% in 2010 while global med imports may soar some 30%.

Now, one area I would like to discuss is Chinese growth. You know there is a certain deja vu element to this roller coaster views about China’s economy. We have long observed the recurring syndrome. China announced it’s targeted growth rate of 8%, the economy outpaces that growth leading to investor skittishness. The government then announces cooling measures to ensure sustainability of growth, but nervousness increases. And finally when the accounting is finished, GDP is growing 9 or 10%, and then the cycle repeats itself. So we regularly expect 8 to 10% plus GDP growth out of China and haven’t been disappointed in any of the past 10 years. Amid the global financial crisis, China even managed 9% growth. In the first half of 2010, GDP grew 11.1%. Now as China lets its foot off the gas just a bit, 2010 GDP estimates have been revised to 10% The U.S. should even be one third so lucky.

Let me offer a few key China data points which we think support the long term energy and coal demand trends. First of all, the simple fact is that yesterday’s announcement that China has become the world’s largest energy consumer is profound. The U.S. held that position for over 100 years. And underneath this some have been concerned that China’s auto sales are easy, but consider that June sales are up 25% from a prior year which itself was up 40% over 2008. GM has announced that it is selling more cars in China than in the U.S. and this year China will sell more cars than any nation ever. The China’s steel intensity per capita is increasing but remains at just half or less than of the U.S., Japan, and South Korea. And China will ultimately pass these nations in steel intensity as housing is being built up versus out. There are hundreds of millions who need air conditioning and appliances that take steel to make and power to run. Also this year, China will pass the U.S. as a leading manufacturer.

China has also just announced a 30 billion dollar investment in the nation’s transmission grid system to further expand electricity availability. China’s power demand growth in June was double digit again and year to date generation is up a robust 19%. So all of this translates into China’s coal demand growing at a rapid clip and coal imports continuing at a record pace. The June numbers just out show another impressive month with China net imports totaling 11 million tons.

So now back to the markets. While we have seen some moderation in the growth of global met coal demand, this has occurred primarily in the lower quality products. Some of the newer steel mills have struggled with blending and have forced greater reliance on high quality hard-coking coal products and expanding the spread among met coal qualities. But overall consumption of met coal remains strong. During the second quarter, the benchmark met coal prices settled at the second highest price ever at $225 per metric ton for the reference price.

And if you look at electricity generation, we see continued demand growth. Power plants starting operation this year represent 340 million tons of annual coal demand. And thermal coal from Newcastle is in the triple digit price range for future years. So the bottom line, we are justifiably bullish in the near term and feel stronger than ever about the long term super cycle for coal driven by Asia Pacific growth.

Now on the U.S., economic activity is yet to fully recover, with much more upside potential in the future. But even so, coal supply demand fundamentals are solid in 2010. On the demand side, coal is gaining market share for power generation and coal consumption by generators is up 6% this year. Power plants are running at high utilization rates with cooling degree days 30% above the average and 49% above last year. Meanwhile U.S. coal production is down some 3% driven by a 12% decrease in Appalachia. Coal stockpiles have declined below prior year levels. The stockpile draw over the past five weeks has been nearly 15 million tons, and that is 8 million tons more than normal. So as a result, PRB and Illinois Basin inventories will be at near normal levels by year end. So you can see why coal prices have marched up in the quarter and continued to set post recession highs in the Powder River and Illinois Basins particularly.

Longer term, we believe we are well positioned. Most U.S. peers have major positions in regions that are likely to see production declines of up to 25 to 30% over the next five years. The Peabody’s key regions, the PRB, Illinois Basin and Australia are set to see growth of between 15 and 50% during that same time. So against this backdrop of global coal markets, Peabody is realizing good prices now, with significant market leverage in future years. Peabody has 20 to 25% of our expected production to price for 2011 and that grows to half our production by 2012.

So if we move to our growth projects, Peabody has major activities in several continents. In Australia, we continue to advance expansions that could take volumes there from 27 to 29 million tons this year up to 40 million tons by 2014. This may mark the official opening of the new NCIG port and which we are the second largest participant. And we also joined the consortium looking at privatizing some of the Queensland Rail assets.

In Asia, we are advancing multiple projects. Most recently we welcomed Winsway as a new joint venture partner in Mongolia. Winsway is the leading importer of Mongolian Coal in the China, that will be a great asset as we develop our licenses and resources. And in the U.S. we began shipments at Bear Run our major new surface mine in Indiana which will grow to over 8 million tons over time. And we continue to make progress in developing a sustainable PRB export off the west coast.

So, in summary Peabody remains committed to sustainable and meaningful growth, we look forward to a second half which is even better than our first and continued expansion into 2010.

Now at this time, I will turn the call over to Mike for a review of the second quarter performance along with a discussion on our outlook. Mike?

Michael Crews

Well, thanks Greg. Peabody turned in a great second quarter that was our best since the onset of the recession. Our operations continue to deliver exceptional results which drove substantial operating cash flows. We refinanced our credit facility gaining greater flexibility to execute our growth plans. And we are raising the mid- point of our EBITDA and EPS targets for the year. I will begin with a review of our income statement and operational highlights.

Second quarter revenues of nearly 1.7 billion were 24% above the prior year on slightly higher volumes. The key driver was Australia where volumes increased 28% and average prices rose 49%. EBIDTA reached 440 million, 35% above prior year on much higher Australia results and solid U.S performance. The increased mining contributions more than offset reduced trading and brokerage activities.

Let me take you through the EBITDA drivers in more detail beginning with Australia where results were 75% above prior year. Second quarter met sales totaled 2.2 million tons more than double last year. Our realized price for met coal averaged $162 per short ton higher than both last quarter and last year reflecting the benefits of new settlements. Second quarter sales were driven by a combination of business priced in line with the industry benchmark and carry over volumes.

On the sea borne thermal side, we sold 2.6 million tones on par with last year at a higher average price of $84 per short ton. Turning now to costs, you will recall that last year we had a much larger mix of thermal coal sales as met shipments were delayed due to price settlement negotiations. In the second quarter, costs were $58 per ton. We continue to target full year Australia costs in a range of 55 to $60 per ton. With higher prices and volumes combined with costs in line with expectation, our Australian margins expanded to more than $34 per ton.

Turning now to the U.S, our quarterly results benefited from higher Midwestern prices and lower costs in the west. Midwestern prices were more than $3 per ton higher than last year. Costs averaged $34 per ton reflecting a combination of lower volumes and start up of the new Bear Run mine. Absent the transition costs associated with Bear Run costs would have increased less than 5%. All told Midwestern margins were nearly 1 dollar per ton higher than last year.

In the west, our margins climbed 33% to more than $5 per ton led by higher volumes and cost containment at our PRB operations. Rounding off the discussion, trading and brokerage delivered $14 million of EBITDA. The decline was a result of lower exports due to the weak Atlantic market along with vessel timing and lower trading levels due to market dynamics. Moving onto taxes, our effective tax rate was 27% excluding currency re-measurement in line with our full year expectations of 25 to 30%.

While on the subject of taxes, I would like to touch on the latest developments in the Australian resource tax. As expected, things have changed quickly in just a few short months. We are encouraged by the changes in the tax game including the reduction of the overall rate and the increase in the producers return threshold to accommodate existing operations. The new proposal is still subject to legislation in late 2011 following an election that has been called for next month. We continue to move forward with our growth plans in the region. After accounting for taxes and $19 million of currency re-measurement, our adjusted income from continuing operations totaled $195 million with adjusted EPS of 69 cents, 38% above last year. And included in the second quarter’s results are 2 cents of charges related to our credit facility refinancing that I will discuss in a moment.

Turning to the balance sheet, our $292 million in cash flows from operations helped to drive our cash balance to more than 1.1 billion. And our liquidity remains strong at 2.4 billion. During the quarter, we successfully refinanced the senior unsecured credit facility, which now consists of a 5 year $.1.5 billion revolver and $500 million term loan. Our new facility was significantly over subscribed and includes a good mix of domestic and international banks.

Capital spending during the quarter totaled 117 million. Our full year CAPEX target remained 600 to 650 million. Looking forward, we expect our growth in EBITDA and EPS to continue. Third quarter EBITDA is expected increased to 475-550 million given higher pricing in volumes. Adjusted EPS for third quarter is targeted at 75 cents to a dollar per share, and we are pleased to be raising the midpoint of our full year outlook. Targeted EBITDA for 2010 is now 1.7 to 1.9 billion with adjusted EPS of 260-315 per share. At these higher levels, we remain on track for 2010 EBITDA that could rival 2008’s record results.

So, with that review of our outstanding second quarter as well as expectations for an even stronger second half, we will be happy to take your questions at this time.

Question-and-Answer Session

Operator

(Operator instructions) Our first question will come from the line of Pearce Hammond of Simmons & Company. Please go ahead.

Pearce Hammond - Simmons & Company

Good morning.

Gregory Boyce

Good morning, Pearce.

Pearce Hammond - Simmons & Company

Great quarter, met coal pricing. Where do you see it right now for high quality met, FOB the port and for lower quality mets in the spot market?

Gregory Boyce

Well, Pearce, as you know we are just recently settled our met coal settlements for the last quarter really just a couple of weeks ago at $225 for the high quality coals and about 75-80% of that number for the semi-softs and PCI quality coals. And that was a meaningful volume, so really since that point in time we haven’t really transacted in the market and frankly I don’t think there has been much volume in the market since that point in time to really give you an indicator of any changes in the price. Of course, we had heard a lot about sentiment [ph] in the last week or two around China but I don’t think that really is much more than noise in the press right now as to what’s really happening because we haven’t seen a lot of changes in the pricing.

Pearce Hammond- Simmons & Company

For the high end of your guidance range for the EPS guidance for the full year, is it fair to assume that that is assuming a met coal price similar to the recently agreed to benchmark?

Gregory Boyce

We try to stay away specifically guiding into quarterly pricing, Pearce, we try to stay away giving that pricing obviously for strategic reasons with the customers to really talk about that in too much detail.

Pearce Hammond - Simmons & Company

That’s fine. And then finally from a rule of thumb standpoint, if we look at the Australian resource super profit tax, if your tax rate for this quarter was 27%, what’s a rough estimate of what it would look like at the time that the resource super profits tax takes effect. What would you think?

Michael Crews

Yeah. This is Mike, Pearce. When you think about the taxes, we look at a combination of both the corporate income tax, the royalties that we pay and then this incremental resource tax. And what was quoted when the RSPT came out initially is that the tax rate all in could be at about in high 50’s because if you look at a 10% rate give or take on the royalties. So we are seeing right now an all in rate of somewhere around 48%. So, it’s just an incremental couple of percent at this point with these provisions based upon our project pipeline as we know it.

Pearce Hammond - Simmons & Company

Great, thank you very much.

Operator

Thank you, our next question comes from the line of Brian Singer of Goldman Sachs, please go ahead.

Brian Singer - Goldman Sachs

Thank you, good morning.

Gregory Boyce

Good morning, Brian.

Brian Singer - Goldman Sachs

Couple of big picture questions, first on the PRB first. How much PRB production do you think you could easily bring on if the market continues to improve? And then longer term how are you thinking about School Creek costs and what you would need to see to make a decision to bring that on?

Gregory Boyce

Sure. Couple of point question there. Let me start with you know what our underlying capacity is in the PRB. And of course when you say bring on quickly that’s you know you go from everything starting out with just ramping up overtime at the operations with existing equipment, to then buy, you know bringing in some of the easily obtainable and short term equipment for additional capacity, maybe some more dozers for overboard stripping and the like. And then you get into the haul trucks and the loading equipment that may take you 12 months or more to get substantial capacity brought back in. But if you just look at our platform, we have been migrating our sales to our North Antelope Rochelle operation with the investments that we made there over the last 3 or 4 years both in terms of loading efficiency and blending capacity. It is in our view the lowest cost most productive operation in the Powder River Basin and is one of the reasons why we’ve seen the cost performance out of the PRB and the margin enhancement that we have. So we’ve been -- continue to load that operation up, but it’s got some capacity because we could be running at higher over time rates.

Then if you look at our Caballo operation, you know we are running that operation in that 24 million ton a year rate and that operation in the past is run at 32 to 34 million tons, but it would take mining equipment to make that happen, particularly trucks. And then the same thing with our Rawhide operation, that operation is you know it’s got about 6 to 8 million tons a year of capacity with additional mining equipment. So, net-net what I am saying is we’ve got additional capacity in the near term with overtime, extra ships, a bit of equipment additional utilization and then as you look out over a period of years, so we were looking at additional capacity for next year, we would have to be looking at trucks you know and bringing those, buying those trucks for delivery in the second half of next year, and then in 2012 obviously you have even more.

Now when you take into account our ability to begin to produce out of School Creek and again School Creek we’ve always talked about in the near term will be a bit of a margin enhancement play for us as we being close to North Antelope-Rochelle, lot of synergies in terms of production of that reserve base. So you know we might begin to ship some of our volumes down to School Creek and you might see that you know even starting next year as we were just going through the planning exercises now. But ultimately, School Creek has the ability of anywhere from 25 upwards of getting up to 35 plus million tons a year of operation. So, as the PRB move forward and is the fastest growing region in the U.S. and gains market share overall in the U.S. we’ve got the capacity to grow with that volume.

Brian Singer - Goldman Sachs

Great, thank you very much, it was really helpful. And then separately on the quarter, your met coal volumes fell relative to the first quarter slightly, obviously the realized prices were higher. But can you comment were there any changes in mix or any reason for the slight downtick in quarter on quarter met? If I recall, maybe the first quarter was little stronger than you thought in the first place.

Gregory Boyce

Yeah, I think you always have to be a bit careful with quarter to quarter comparables out of Australia. I mean a couple of vessels moving between shipping on the last day of the quarter versus the first and second days of the following quarter have a big issue with volumes. In some cases our volumes are slightly impacted, it can be impacted by what our competitors are doing; most of these vessels are blended vessels. We may have coal available to ship and then I will tell you all of this quarter we had coal available to ship, in some cases we were delayed because our competitors in Australia were having operating problems. We do our best to mitigate those during the quarter, but all that means is volumes move around bit by bit particularly at the beginning and the ends of the quarters. One of the reasons why our ranges are where they are is because you know one high priced vessel and you are looking at potentially $10 million swing in earnings. And maybe if you miss it just by 4, 5 hours in terms of getting a vessel to sail out of the port. So I think overall we were pleased with the performance, had full coal availability been where it needed to be, we might have been able to get 1 or 2 vessels but for the year, it all averages out.

Brian Singer - Goldman Sachs

Thank you very much.

Operator

Thank you. Next we will go the line of Jeremy Sussman at Brean Murray. Please go ahead.

Jeremy Sussman - Brean Murray

Hi, good morning.

Gregory Boyce

Good morning.

Jeremy Sussman - Brean Murray

Greg, you talked about the expanding quality spread, I believe, expanding spread among met coal qualities, I assume that in terms of pricing and may be demand, can you, would you mind just elaborating on this a little bit?

Rick Navarre

This is Rick. Actually when you look at the met coal qualities, over the last several months there was a lot of lower quality met coal has entered the market as you are aware, that was blended and moved in. And a lot of customers were having some difficulty with some of that coal. So we have seen a return by our customers looking for higher quality coal to offset some of the lower quality coal they committed to. And so we are seeing a stronger demand for the higher quality products that we produce mostly out of Australia.

Gregory Boyce

Okay. Yeah, Jeremy, just to add a bit, I mean it’s no different than steel. You know, not all steel production is of the same quality and depending on what the underlying demand is for steel, whether it’s for the average pipe type qualities or some of the specialty steels, same thing with the met coal. And what we have seen is a really strong, strong demand for the higher quality met coals. Everybody needs those to blend off and around, and as Rick said what we saw was a bit of exuberance in terms of the amount of stuff that was moving into the market that is questionable whether it was met coal but people were taking it and trying to blend with it, and there has been a bit of backing away from that and more pressure now on the higher quality coals.

Jeremy Sussman - Brean Murray

Great, no, that’s very helpful, and then just a quick follow up. You know any change in sort of how you are viewing potential acquisitions sort of you know now that you know I guess we are couple of months removed from everything that you went through with Macarthur which I assume is mostly met coal PCI driven at the time?

Gregory Boyce

I don’t think there is anything that has fundamentally changed our views long term and/or what the underlying drivers for you know that acquisition target or the others that we look at. You know we are still very acquisitive and continue to look for opportunities that will provide a good acquisition to add to the portfolio, you know particularly in the sea borne traded coal commodities.

Jeremy Sussman - Brean Murray

Perfect, thanks very much.

Operator

Thank you. And next we will look at the line of Mark Liinamaa at Morgan Stanley, please go ahead.

Mark Liinamaa - Morgan Stanley

Hi, unless I missed it, I didn’t hear any comments about the west coast port, can you talk a little bit about how you might see that business model unfolding and does it have to be a kind of a Peabody only type effort? Thanks.

Gregory Boyce

Well, I mean obviously you didn’t miss it, we didn’t have much detail included in our comments and that was by design, because all of this is a bit early stage and still going through a fair bit of base load work in terms of where the optimum locations might be and what would make sense. So we are being a bit careful in what we say. But having said that our initiative is what can we do in volume and quite frankly what can we do in volume for Peabody in order to move you know PRB coals into the Pacific rim, but as well as what can we do for our other coal products in the U.S., Illinois Basin and even Colorado into the International marketplace. But you know you will hear as it unfolds we will provide more information on progress that we are making but it’s just in a period of time where we would like to not to go into too much detail. Suffice it to say there is a tremendous amount of work that’s taking place and our initiatives are focused on what can we put in place that will provide us a significant volume of capacity for PRB coals out of the west coast.

Mark Liinamaa - Morgan Stanley

But would you see it as something that tightened the market or something to find a home for your ability to grow production?

Gregory Boyce

Both.

Mark Liinamaa - Morgan Stanley

Okay. And then can you just may be touch on your confidence level that something can happen in Mongolia before the election, and how things are going there?

Gregory Boyce

Well, they are already off on their holidays. So I mean Mongolia, the legislature has put together a very broad frame work now for moving forward on TT, but they are all on their national holidays now and then they will go into their election period. So there will be some engagement over the next month, but we really think it’s probably going to be the beginning of fall before we have re-engagement at a more substantive [ph] detailed level and obviously we still feel very good about the positioning that we have placed Peabody to be a participant in that process.

Mark Liinamaa - Morgan Stanley

Okay, so you are still confident. That’s great. Thanks, guys.

Operator

Thank you. Next we will go to the line of David Khani of FBR Capital Markets. Please go ahead.

David Khani – FBR Capital Markets

Yeah. Hi, gentleman.

Gregory Boyce

Good morning David.

Gregory Boyce

Hi, David.

David Khani – FBR Capital Markets

With I guess the trading numbers coming down for this quarter and you mentioned sort of some of the reasons. What’s the outlook you think for the remainder part of the year? And then I guess second part of it is with some of the new offices that you have opened up, are you starting to see some of the fruits of labor from those new offices?

Rick Navarre

Yeah, David this is Rick. I will touch on that. We are seeing some improvements in our numbers and in our volumes initially from the expansion of our trading platform across the globe for sure, and you can see that in our international numbers have been taken a larger share of the total trading high, if you will. When you look at what happened in this particular quarter, I will give you a couple of things that obviously reduced export volume by the United States because what’s happened in Europe with lower prices had an impact. We had a couple of shipments that didn’t go out for variety of reasons due to the equipment issues or other things so we missed a couple of shipments, we will get those back later in the year. And then really just the last piece would be last month or two, we had strong pricing across the Pacific markets and European markets, but it’s had limited volatilities. It’s been in the high 90s but now with very little volatility, very little liquidity. So we pretty much sat on the sidelines for this quarter, because there wasn’t a lot of direction, and that causes to a bit lower on our trading profits than we liked to be. But if you look at the last two years, David, we have been running 30 to $40 million per quarter and we returned to the normal volatility that we think the market will go back to and get liquidity in the market, we think we can return to those same numbers. But we do need to see those things come back to the market.

David Khani – FBR Capital Markets

But then with these new offices, you would expect those numbers, the 30 to 40 million to trend up over time, wouldn’t you?

Rick Navarre

Well, I think over time. It takes time with anything. We approach trading very cautiously and we move into it slowly and make sure we get our feet completely and firmly on the ground before we make a lot of take major positions in this markets.

David Khani – FBR Capital Markets

Okay. And then the second question would be what’s you view for imports of both steam and met into China specifically for 2010 and 2011?

Rick Navarre

My best guess, David, is about 125 to 135; that would be my number. I think on an annualized basis if you look at the data that just came out today probably takes you into 140-ish number. I think if we run closer to what we just saw in June, it will be 125 to 135, could be surprised on the upside, doubt I will be surprised on the downside.

David Khani – FBR Capital Markets

And that’s combined, so…

Rick Navarre

Yeah, that’s met and thermal.

Gregory Boyce

That’s a net number on a combined basis.

David Khani – FBR Capital Markets

Okay. And then directionally, I mean if you don’t want to commit to a 2011 number, is it up?

Rick Navarre

I’d say it’s at least to that number. It’s a little early to say up yet but I would say I don’t see it going down.

David Khani – FBR Capital Markets

Okay, great.

Rick Navarre

David, I spent the last week in China having lot of discussions around this topic and I feel pretty good about that.

Gregory Boyce

Yeah, I mean as you recall, David, we’ve been talking about it increasing for a number of years and everybody thought it was going to go and retrace back to a much lower levels. I mean I think as you look at the underlying energy demand and economic demand in China and where it may go, not only through the back half of this year but then in the next year, as Rick says, we feel very confident, it’s going to stay strong. But I would say early days, the underlying fundamentals would say, it may even continue to increase, maybe at a slower rate, but continue to increase.

David Khani – FBR Capital Markets

And would you feel more confident on the steam side versus met or met versus steam? What do you think is going to grow either percentage or actual tons more the steam side or the met side into China?

Gregory Boyce

Yeah, I think they are both going to grow. If I’d have to say which one I think may grow little bit more, it might be the met coal, you know, given where the steel sector is and where the demand is, but their electricity generation has got longer legs in terms of compound annual growth rate over the next ten years. I think versus where their met coal is, it is just that they are structurally short of met coal.

Rick Navarre

Yeah, you could see more volatility in the met coal side because of policies and the way they manage the steel industry. But when it comes to, as Greg said, the long term fundamentals of electricity demand and fundamentally where the demand is, with the costal plans and all the logistic issues, the steam coal demand is going to be there.

David Khani – FBR Capital Markets

Great, thank you.

Operator

Thank you. Next we will go to the line of Paul Forward at Stifel Nicolaus, please go ahead.

Paul Forward - Stifel, Nicolaus

Thanks good morning. On the Australian volume guidance you have 27 million to 29 million unchanged; first half was just 12.6. So I guess if you were to take the mid-point of your guidance, your implied guidance for the second half of the year that will be about 15.5 million tones, or about 7.7 million tones a quarter. Is all the incremental step up NCIG or would you expect volumes elsewhere to rise as well?

Gregory Boyce

Well, I think the vast majority of it would be NCIG, no question Paul, although we do anticipate some slight increases elsewhere. The Queensland particularly DBCT chain is running better midyear than it was early in the year, we expect that to continue after a bit of maintenance work you know this month. And so we expect a bit stronger back half of the year out of Queensland and then with the NCIG port additions continue to ramp up in New South Wales.

Paul Forward - Stifel, Nicolaus

Alright, thanks. And looking at the western US, I thought the cost number was a really good one in the quarter. Just if we compare this quarter to the year ago, prices were about unchanged and volumes were up just slightly, but costs were down 10% again about a $1.28 per ton, I was just wondering if you could provide a little bit more detail on what drove this cost decline and if we can keep those kind of cost levels in the second half of the year?

Gregory Boyce

Well, I think you know as I said earlier, if you recall the investments that we made in the Powder River Basin over the last three or four years in terms of up scaling our shovel fleet, our truck fleet, the major drag line work that we did and then in-pit crushing and conveying and blending facilities at North Antelope Rochelle, all of those were designed to structurally reduce as much as possible our operating costs particularly out of North Antelope Rochelle. So as we continue to load that operation up, we have seen those benefits. But I would also say our operating team has spent a considerable amount of time; and we have talked about it a bit in New York on all of our operating efficiency and our maintenance programs. We really benefited this quarter from a number of maintenance activities that we normally would have had to do that our operating and maintenance practices have allowed us to extend out and get higher utilization and higher life from major components and pieces of equipment. So, some of the savings this quarter are permanent, some are just timing quarter to quarter, and you know we’ll see some of those now have moved into the third quarter. But we expect some of the ones we had budgeted and planned for the third quarter will move out as we continue to get better and better and have higher efficiencies. So, I think that was a big component of it. Mike, any other color in terms of the details of the costs?

Michael Crews

No, I think you hit on it. So we’ve had slightly higher volumes and the big change really has been where we have been on maintenance. I talked about it last quarter that we had a very strong shipping month in the first quarter that also pushed a couple of things out. So it’s a combination of maintenance optimization and also strong shipping and you know some of that may get pushed into the third quarter.

Paul Forward - Stifel, Nicolaus

Alright. Thanks very much.

Operator

Thank you. Next we will go to line of Kuni Chen at Bank of America Merill Lynch, please go ahead.

Kuni Chen - Bank of America Merill Lynch

Hi. Good morning everybody.

Gregory Boyce

Good morning Kuni.

Kuni Chen - Bank of America Merill Lynch

I just wanted to circle back to the proposed tax changes in Australia. My understanding is that there is an ability to write off growth CAPEX investment there, so is it possible over the next couple of years that you can actually generate a tax benefit out of your Australia operation?

Gregory Boyce

Well, there is a couple of different components here, there is the write off of your existing asset base and they changed the rules because they originally started with book value over accelerated basis over a five year period and they have now allowed you to look at the market value. But that’s frozen really in the May 2010 timeframe. As you start to look at projects because this wouldn’t come until 2012 anyway, so it wouldn’t have an impact on our tax rate for 2011. As you get into 2012, there could be some potential for write off, immediate write off of some capital investment at that point.

Kuni Chen - Bank of America Merill Lynch

Okay, but do you have sense directionally as to whether that’s -- in other words those two would be a net positive or negative?

Gregory Boyce

Yeah, overall tax rate?

Kuni Chen - Bank of America Merill Lynch

Just for Australia.

Gregory Boyce

I think it just really remains to be seen where we are in the timing of our capital investments as we get into that 2012 timeframe.

Kuni Chen - Bank of America Merill Lynch

Okay, Brian, fair enough.

Gregory Boyce

Whatever you do there, you do have to be conscious as to how that’s brought back to the U.S. and then integrated into our overall tax structure. That’s why I think we continue to try and provide guidance on our overall tax rates because we do have a lot of moving parts within the system.

Kuni Chen - Bank of America Merill Lynch

Okay understood. And just sort of follow up, can you gives us some color on what you are seeing as far as vessel queues out of Australia if you compare July relative to May or June? Thanks.

Gregory Boyce

Well I think certainly as you look at Newcastle I think the Newcastle port has been running reasonably well. I mean the queue is such and the loading timeframe is within the window. You would expect almost at a normal level and a 14 day kind of thing. Queensland DBCT is still dealing with the high queue but if you refer back to my comments earlier about how some shippers had operational problems and didn’t have coal availability, for ships that have multiple cargos on them and one shipper doesn’t have the coal, they get delayed and they get -- they stand in the queue, and other ships will then go around them. So you know it’s -- you just can’t take the total number of ships and assume that’s the total length of time that everybody is going to be incurring vessel by vessel. So some vessels are coming in and being loaded as soon as they arrive, some are having to wait multiple weeks for coal to be available. But overall, the demand for met coal out of Queensland is still very strong, that queue is longer, and even though the port has performed better you know that queue has not come down appreciably.

Kuni Chen - Bank of America Merill Lynch

All right, thank you.

Operator

Thank you. And next we will go the line of David Gagliano at Credit Suisse. Please go ahead.

David Gagliano - Credit Suisse

Great, thanks. It looks like the figures in the press release implies you sold forward a fairly meaningful amount of U.S. thermal coal for 2011 delivery. So my questions are how much did you actually sell forward for 2011 delivery during the quarter? And then if you can provide us the average prices for those forward sales and hopefully break it down by region, that would be great? That’s the first question.

Gregory Boyce

Very good try, Dave. 20 million tons, approximately 20 million tons was sold for 2011 delivery in the quarter.

David Gagliano - Credit Suisse

Okay.

Gregory Boyce

As you can expect, just like -- you know it’s broken down, principally it’s going to be the Midwest and Powder River Basin, largely in the Powder River Basin. About half of that was reopener. So what was just actually sold that was uncommitted was probably about 10 million tons.

David Gagliano - Credit Suisse

Okay, is there a reasonable….

Gregory Boyce

Not going to get into prices probably in much detail.

David Gagliano - Credit Suisse

Is it reasonable to assume it was priced around forward curve type…

Gregory Boyce

Oh, yeah, certainly would be forward curve plus, I think, safe with that.

David Gagliano - Credit Suisse

Forward curve, and roughly was that relatively evenly spread throughout the quarter, was it you know early in the quarter, late in the quarter, when was most of that priced?

Gregory Boyce

You know, it varies. I think it was probably I’d say pretty even I guess is the best way to look at it. If you think about each particular sale some of these sales go into 20 million tons sales, but I think pretty evenly. But the price you know, as you know PRB prices continue to march up throughout – have been marching up and we think they will continue to march up based upon what we are seeing and what we are feeling what’s happening with inventories. And you know the people begin to start looking at what they need for next year and so feel pretty good about where pricing is headed.

David Gagliano - Credit Suisse

Okay, great, that’s helpful. And then just as a quick follow up, you mentioned there was some Bear Run start up costs that flowed through the Midwest costs line, and I was wondering if you would just quantify those costs and when do you expect those startup costs to come to an end?

Gregory Boyce

Yeah, when you look at it on a sequential basis, it was about a dollar a ton from the first quarter to second quarter.

David Gagliano - Credit Suisse

Dollar per ton, and should we expect those to come to an end?

Gregory Boyce

Yeah, I think that you are at the largest part of the impact you are going to see within the second quarter. So we will start to see that smooth out as we look at our full year costs.

David Gagliano - Credit Suisse

Great, okay thanks very much.

Gregory Boyce

Thanks Dave.

Operator

Thank you. Our next question comes from the line of Curt Woodworth of Macquarie. Please go ahead.

Curt Woodworth - Macquarie

Hi, good morning everyone.

Gregory Boyce

Good morning Curt.

Curt Woodworth-Macquarie

Greg, I have a follow up question on the coking coal volumes not necessarily for the quarter but looking back for the past 2 quarters you had sequential declines basically since the 3rd quarter of last year. I know that doubtful scheduling and competitive issues can impact a quarter but you still the last 3 quarters have been shipping fairly well below 3rd quarter ’09 yet steel production is up a lot, the rails running better, you have the (inaudible) upgrade on the Queensland lines, so I am just wondering you know what do think your normal capacity and shipping level is out of DBCT right now? And then I have a follow up.

Rick Navarre

Curt, this is Rick, let me address the 3rd quarter of ‘09 because I think what you are looking at is an anomaly. When if you recall last year in the first half of the year we didn’t ship very much met coal because of the issues. We were still negotiating over the carry over pricing discussion with our customers, and so we mostly were largely shipping thermal coal. And once we settle pricing and settle the carry over issues, we shipped a lot of met coal in the third quarter, it’s been a huge, huge back up. So that was an unusual quarter to compare to, so you really pretty much have to look at not look at that quarter. And because the whole half first half of 2009, it’s only 1.8 million tons of met coal, and then in the third quarter we have 2.9 million tons. So it is unusually a little bit higher, but more likely if you look at the average right now, we are averaging probably 2 ½ to 3 million tons a quarter is what you can expect for the met coal going forward.

Curt Woodworth - Macquarie

Okay, so alright 2 ½ to 3. Then in terms of China, so China right now is around, call it 15, 20% of sea borne demand, and I’m wondering how much are you guys selling to China right now, may be just a sense of what proportion of your mix and have you seen any changes in that mix recently?

Gregory Boyce

Last year, I think we have probably sold 5 million tons to China last year. I’d say that mix is pretty consistent and may be down just a little bit on the thermal side out of Australia as Indonesia has taken a little bit more of that business, but Australia has picked up more on the met side.

Curt Woodworth - Macquarie

Yeah. Okay, thank you.

Operator

Thank you. And next we go to the line of Michael Dudas of Jefferies. Please go ahead.

Michael Dudas - Jefferies & Company

Thanks, good morning everyone.

Gregory Boyce

Hey, Michael.

Michael Dudas - Jefferies & Company

Two questions first. Bear Run, remind us on the base load aspect of the contracts that you have assigned to the production there. Is there opportunity to sell above base load tons into the marketplace and does the market look reasonably either from a domestic or an export stand point to position coal at much higher prices?

Gregory Boyce

Yeah, couple of things. I mean the base load contracts at Bear Run you know approximately 75% of that 8 million ton production rate. But we should remind folks that when we built Bear Run we built the infrastructure including the prep plant to be able to easily be expanded up to 12 million tons a year. And so as we, you know as we look at where the market is at, both in terms of domestic and the Illinois basin growth, you know there’s opportunities to take advantage of what’s happening in the spot business as well and/or additional contract business.

Michael Dudas - Jefferies & Company

But is that 8 to 12, is that a multiyear phase in?

Gregory Boyce

Yes, it would be a multi year phase in. We built the prep plant big enough to get up to that level. But we would have to buy the equipment, the screens and the spirals and the like inside. Basically I had another circuit to that prep plant in order to get up to that level and some additional mining equipment. So, it would take a couple of years to get up to that level.

Michael Dudas - Jefferies & Company

My second question is regarding cap spending, certainly looks like second half of the year is going to be accelerated for what you did in the first half. Could you remind us where that delta is being allocated above your maintenance level spending. And as you get an early look to 2011, and with the five year growth plan, are we going to see significant ramp ups in that type of run rate and/or just a little bit sense of when the timing would be to start seeing additional capital ramp up with your current growth opportunities?

Gregory Boyce

I think on the CapEx front for the rest of the year, we running at about 221 I think on the first half. So clearly we got some back loaded expenditures as a couple of different things going on there. A lot of that is in Australia, it’s production equipment for the underground operations that is more backend weighted as we went through the budget process and where we are looking at lead times. Equipment in general on a sustaining basis is a little more back loaded. And then finally there is fairly large component of that overall total related to our Australia projects and you have metropolitan expansion that will have some, incurring some charges on, but probably the larger one is the box cut capital that we have in our current operation. So we will start moving it into our back half of the year and that will drive up the expenditure as well.

Michael Dudas - Jefferies & Company

Well, let’s first say, early look on ‘11 is the second half run rate kind of give or take where you might be in ’11? Are there opportunities that you haven’t really brought to us yet, maybe possibly in the U.S. or else where maybe some of these joint ventures and investments that could bump that up?

Gregory Boyce

Yeah, it’s early in our cycle for next year to be really trying to give any kind of guidance, obviously, know what our sustaining levels are on a project basis. We are now going through fairly extensive project reviews to see what we will add for next year.

Michael Dudas - Jefferies & Company

Fair enough. Thanks gentleman.

Operator

Thank you. Next we will go the line of Shneur Gershuni at UBS. Please go ahead.

Shneur Gershuni - UBS

Hi, good morning everyone.

Gregory Boyce

Good morning.

Shneur Gershuni - UBS

Most of my questions have been asked and answered but if I can just have one follow up question to David’s question before with respect to PRB pricing. You know your operation is currently right now you know is running at less than you know optimum operation. You talked about different ways that you can move the production up and so forth. Are these the price levels that once you sell out for next year that you would be happy enough to move up your production levels or would you prefer price to be above this level before you would bring on incremental tons to where you are currently operating at?

Gregory Boyce

Well, there is no question that you know the price levels that we’re starting to see in the out years provide a margin for our PRB. But you know obviously we want to see things sustainable before we are going to make major moves in terms of production changes.

Shneur Gershuni - UBS

Absent any change in the curve right now, you are probably going to continue to run at the same run rate?

Michael Crews

Yeah, within reason, I think – actually, I think if you look at the curve right now, I’d say that the PRB curve has some work to do, to be honest with you. I think when you compare it to the other price curves in the other basins, both domestically, internationally, there is -- it’s too flat to be honest with you. It’s tightened up and it needs to get – it needs more upward pressure on the out years on the pricing.

Gregory Boyce

Particularly for anything that would require capital allocation.

Shneur Gershuni - UBS

Great. And my second question, you guys have expressed some frustration in the past with respect of evaluation and so forth. You have a share buyback that’s authorized and you know given the current share price level, are you more incentivized or more interested in potentially pursuing some share buybacks as an opportunity to deploy some of the capital that you have given? You have over a billion on hand at this point right now.

Gregory Boyce

Well I think your overall question is, what is our plan for all of this cash that Mike has accumulated in terms of our liquidity. And as we’ve always said, our first choice is growth. And Rick and the commercial team just have been tireless in terms of looking at opportunities, as well as you know I indicated we are going through beginning our project review cycle. We want to see what you know major growth projects we have in our granite platform, what the timing would look like, so we can really access what our cash needs are going to be, all with a growth driver, first and foremost. Then beyond that, you know we continue to look at what our capital structure is, you know what makes the most sense in terms of debt levels. We’ve got the potential for share repurchase, we have got potential for dividend changes. So, we look at all of those. But I don’t think anything’s changed in terms of our view that to the extent we can take that cash and deploy it in growth opportunities that would be the highest use for that cash.

Shneur Gershuni - UBS

Great, thank you very much.

Operator

Thank you. And our next question comes from the line of Garrett Nelson at Davenport & Company. Please go ahead.

Garrett Nelson of Davenport & Company

Good morning everyone. Just a follow up clarification on Bear Run, the press release says that sales are expected to average 3 to 3.5 million in 2010. Did you mean to say that Bear Run sales are expected to total 3.5, 3 or 3.5 million tons, or is that kind of a annualized monthly run rate that you are expecting for the balance of the year.

Rick Navarre

Yeah, it’s expected to be the total, it’s probably – it’s the total.

Gregory Boyce

It’s the total for this year because it just started off, but it grows to 8 million tons per year once it gets up to full production, which is probably not quite totally next year but certainly 2012.

Garrett Nelson - Davenport & Company

So the mine started up in May and you are expecting it to do three to three and half for the full year?

Gregory Boyce

That’s correct

Garrett Nelson - Davenport & Company

Great. Okay thank you

Operator

Thank you. And our next question will come from the line of John Bridges at J.P Morgan, please go ahead.

John Bridges - J.P Morgan

Hi Greg, everybody. Just a couple of follow ups, I just got a sense that the amount of contracting you have done for the US this year is perhaps ahead of the normal rate? Is that true, is that policy just worked out that way.

Gregory Boyce

Well, John, I think if you recall, we began the year ahead of the normal rate because of where the market was, and what was happening with the economy. You know we entered 2010 largely sold out intentionally and we actually sold out more of 2011 than we would normally have sold out. So you are right, we entered more sold out than normal and so that’s where we are at today. And it was up by design because of the softness in the market.

John Bridges - J.P Morgan

Okay interesting. And then –School Creek, presumably the comment you made is more of a replacement tons next year if it comes rather than any incremental tonnage?

Gregory Boyce

That’s right. I mean we are looking at it as a margin expansion opportunity. So it would be shuffling some tons around within the portfolio. I mean we are not saying what our PRB volumes are going to be next year, but to the extent that whatever we set that level at, we may take some of those tons from School Creek in order to enhance the margins.

John Bridges - J.P Morgan

Okay, got it. And then given the importance of the dollar exchange rate, what is the hedging policy with this respect to the Aussie dollar?

Michael Crews

John, what we typically do is on a programmatic basis if you will we would layer in hedges over time. And the primary function of that is really to limit volatility. So we will look over a three year period we have taken. We saw some dips in the market earlier in this year and we extended that out just a bit to take a smaller position on later periods. But we are really looking on an average, it’s a sliding scale of how much we will hedge over three years.

John Bridges - J.P Morgan

And it’s a pretty mechanical process?

Michael Crews

It’s a combination of – we will layer in hedges on a month to month basis to maintain a base load of what we were looking to do largely in relation to how much we have contracted But given our view of the coal markets, we will look at the coal relations around that and where we think the currency exchange rates are going to be, we will take that up or down as we take a view.

John Bridges - J.P Morgan

Do you make much money on the hedge?

Michael Crews

Well, the goal is really not to make money; it is to limit the volatility. But it has – and we talked about this at the analyst meeting; actually, we have added I think it’s over a $100 -- or $100 million in value over the five year period.

Operator

Thank you. And we have time for one more question, and that will come from the line James Rollyson at Raymond James & Associates.

James Rollyson - Raymond James & Associates

Any thoughts what are you guys thinking on the proposal to privatize the Queensland coal rail track?

Gregory Boyce

Well, as I indicated, Jim, we are part of the consortium of companies that are looking to privatize at least at this point the track in Queensland, not the above track or the moving equipment, but the track system itself. The view is who best and who most motivated to make sure that that track system is not only maintained, but also capital investments take place to ensure the availability of volume capacity for moving of coals out of Queensland but the producers of the coal. And so we think it is a strong consortium that has been put together, all of the producers essentially, and we made a strong bid. Queensland government is still analyzing, evaluating exactly what they want to do with those rail assets but the strategy would be to better align the planning and the investments and the capacity and the rail track to what the mine operations themselves are planning going forward.

James Rollyson - Raymond James & Associates

That always seem to be the weakest link on the growth aspect, so any idea when you might hear something about that?

Gregory Boyce

No, it’s frankly been a pretty fluid process, and now we have got Australian national elections coming next month, so it’s pretty tough to say. I don’t think it’s going to drag on for six months or more, but I think we are going to hear something and see where it evolves to over the course of the next quarter or so.

James Rollyson - Raymond James & Associates

Great. Thank you guys.

Operator

Thank you. And now, I will turn it back to Mr. Boyce for any closing remarks.

Gregory Boyce

Well, I want to thank everybody for your interest in BTU and your time with us this morning. Obviously we believe there is a lot to like about our position. The markets are strong, our operations are performing very, very well. As you have seen the results are positive and our outlook continues to strengthen. I would also like to thank our 7,000 employees around the world for their continued attention to safe, low cost operations. And with that, thank you very much for participation this morning.

Operator

Thank you. And, ladies and gentlemen, today’s conference will be available for replay after 12:30 p.m. Central Time today until August 20th at midnight. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701 and entering the access code of 163141. International participants may dial 1-320-365-3844 again with the access code of 163141. That does conclude your conference for today, thank you for your participation and for using AT&T executive teleconference service.

You may now disconnect.

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Source: Peabody Energy Q2 2010 Earnings Call Transcript
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