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Summary

  • Company has diverse and high-quality asset base.
  • Remains committed to reducing operating costs to support bottom line results in tough industry conditions.
  • Retains option to sell non-core assets to improve liquidity and repay portion of outstanding debt.

The U.S. coal industry has been going through difficult business conditions due to tougher environmental regulations, excess met coal supply and rail issues in the PRB region. To survive the ongoing tough conditions, coal companies (Peabody Energy (NYSE:BTU) is no exception) have been reducing costs, cutting CAPEX, selling non-core assets and extending debt maturities. Despite the tough business conditions, I believe BTU remains the best coal stock and a good investment option for investors willing to play a coal market rebound. BTU has a diverse operational and assets base, with operations in Australia and the U.S. The company owns high quality assets, as it has assets in the low-cost regions of PRB and the Illinois Basin. Coal production from these regions stays competitive, even with gas prices of $4 mmBtu. Also, the company has strong liquidity to survive the industry downturn.

Financial Performance

The company reported better than expected results for 2Q14, mainly driven by strong U.S. coal pricing. The company reported EBITDA of $213 million, better than consensus estimates of $161 million for 2Q14. Total revenues for the quarter came out to be $1.76 billion, in comparison to consensus estimates of $1.63 billion. The beat was driven by higher than expected U.S. pricing for the quarter - actual price of approximately $22.2 per ton, in comparison to consensus estimates of $20 per ton.

As the industry conditions remain tough, BTU continues to improve its cost structure. The company has been making aggressive efforts to lower costs, which will help it preserve cash in the tough conditions. The company has been idling its high cost mines and improving operational efficiencies. BTU expects to reduce its U.S. operation costs by 1%-3% year-on-year in 2014. Also, the company earlier this week lowered its Australian operations cost guidance to a low $70 per ton range, from a previous guidance range of low-mid $70 per ton, due to the planned coal production reduction at its Burton mine. Also, as a result of lower met coal production, BTU increased the Q314 EBITDA guidance by $10 million to $150-$200 million. BTU's cost control efforts will support its bottom line numbers in the tough industry conditions.

Rail issues in the PRB region continue to weigh on coal companies' performance. In 1H14, BTU lost approximately 15 million tons of PRB coal due to rail issues. Rail issues are likely to prevail in 3Q14, and conditions are expected to start improving from 4Q14 onwards. Due to rail issues, some of the contracted coal might not be delivered by BTU in 2H14, resulting in rollover to 2015. Also, due to ongoing rail issues, the company lowered the top end of its U.S. thermal coal shipment estimates by 5 million tons for 2014.

Once the ongoing rail issues are resolved, the U.S. thermal coal market is likely to improve due to inventory rebuilding at power producers and an increase in natural gas prices. According to EIA estimates, natural gas prices are expected to remain above $4 mmBtu in the future. Also, coal-fired electricity generation is expected to increase by 2% year-on-year in 2014, which will portend well for the coal industry.

On the other hand, the met coal market is likely to remain weak in the near-to-medium term, mainly due to excess coal supply. The met coal benchmark price for 3Q14 settled at $120 per ton. Despite met coal production cuts of approximately 40 million tons in the last two years, the met coal market is believed to be still oversupplied by 30 million tons, calling for more production cuts, according to Moody's. Arch Coal, Cliffs Natural Resources (NYSE:CLF), Alpha Natural Resources (NYSE:ANR) and BTU have responded to weak met coal prices and announced production cuts. Earlier this week, BTU announced a plan to lower its met coal production from its Burton mine in Queensland, Australia.

Solid Liquidity
Despite the tough industry conditions, the company has strong liquidity. BTU ended 2Q14 with a total liquidity of $2.1 billion. With a total liquidity of $2.1 billion and no near-term convent issues, I believe BTU remains attractive among U.S. coal stocks. Also, the company has been making efforts to improve its financial flexibility and preserve cash in the tough business conditions by reducing operating and capital expenditures. Recently, BTU yet again lowered its CAPEX guidance by another $40-$45 million to $210-250 million tons for 2014. The company has lowered its CAPEX in the recent past, as its CAPEX totaled $986 million and $328 million in 2012 and 2013, respectively. The company also has an option to sell its non-core assets to improve its liquidity. BTU sold $160 million worth of assets in 2013. Also, the company can use proceeds from the sale of non-core assets to repay debts. The company has repaid approximately $600 million of debt since the start of 2012.

Conclusion
I believe BTU is the best stock to play a coal market rebound. The company has a diverse and high quality asset base. Also, the company remains committed to reducing its operating costs to support its bottom line results in the tough industry conditions. Moreover, the company has a strong liquidity position, and has been taking corrective measures by lowering its CAPEX to preserve cash in the ongoing industry downturn. BTU also has an option to sell non-core assets to improve its liquidity and repay a portion of its outstanding debt.

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

Source: Peabody Energy Remains The Stock Of Choice To Play Coal Market Rebound