While the Obama administration continues to wage a war on coal in the U.S., Australia recently repealed a carbon tax after two years in existence. The decision by Australia to remove the higher costs on coal from the carbon tax could help the proponents of the restrictive legislation back in the domestic markets. Either way, the move by Australia provides some hope for a reversal of fortune of the largest domestic listed producer of coal in Peabody Energy (BTU).
The stock continues to lag at multi-year lows though coal demand remains reasonably strong. The supply/demand economics remain an issue causing Peabody Energy to again slash expectations for the upcoming quarter. With other coal miners in the U.S. and abroad slashing high-cost production as losses mount, the sector might finally have some hope for a turnaround.
The issue with Peabody Energy isn't exactly the current financial results, but rather the outlook for the coal markets. For starters though, let's quickly review the Q2 financials and guidance for Q3 and beyond.
The Q214 numbers were basically in line with greatly reduced expectations over the last couple of years. The company lost $0.28 per share, in line with expectations, while revenue of $1.76 billion beat expectations though it only grew 1.7% over the prior year period. Adjusted EBITDA was a decent $213 million.
The original guidance for Q314 is where the story got scary as Peabody Energy forecast a substantial sequential decline in the important metrics. The company forecasted adjusted EBITDA to plunge to $140 million to $190 million and for the loss per share to widen to nearly $0.47 at the midpoint.
A few weeks after the earnings release, the company raised guidance due to lower costs in Australia from cutting metallurgical coal output at the Burton Mine. The move to reduce output increases adjusted EBITDA by $10 million on average and reduces the loss per share to roughly $0.43 at the midpoint.
Australia Carbon Tax Repeal
In a move that provides some hope for coal miners, Australia voted to repeal the carbon tax law a few weeks back. The law placed a price on greenhouse-gas emissions increasing the cost to produce electricity from coal, amongst other activities.
Though Australia is listed as one of the largest producers of carbon dioxide emissions per capita amongst developed nations, the law was blamed for rising energy bills and living costs. Interestingly, the EIA lists Australia at 18.0 metric tons back in 2011, only slightly above the 17.6 metric tons of the U.S. The Australia issue of higher costs caused by the strict carbon laws should help alleviate the pressure for restrictive regulations in the U.S.
Though the repeal of the restrictive regulations in Australia is short-term positive, it doesn't change the sentiment in the world to move away from coal towards renewable energy or cleaner natural gas.
Overall Resource Potential
Anybody interested in the coal market or Peabody Energy should review the recent corporate presentation. The company forecasts a few interesting trends including an actual increase in domestic coal demand despite the expected coal plant retirements due to increased utilization at remaining plants. The following slide from a corporate presentation highlights an expected 100 million ton increase by 2016.
While the U.S. demand increase in the next few years seems implausible, Peabody still expects substantial international growth from Asia for the next decade. The company forecasts global demand to soar to 9.16 billion tons from roughly 7.8 billion tons in 2013.
So if demand hits the targets set forth above, the coal stocks will rebound substantially assuming the removal of supply. As mentioned above, Peabody recently cut Australia met coal production by 1 million tons while domestic miner Alpha Natural Resources (ANR) made a substantial cut to operations in West Virginia.
In total, Alpha Natural is cutting an incredible 1,100 employees working at 11 surface mines in that state. The shuttered mines produced 4.2 million tons of Central Appalachia coal during 1H14. With analysts forecasting the coal miner to have substantial losses for the next couple of years, the miner was left with no choice but to continue slashing production at high cost mines in that region.
While other mining stocks like Alpha Natural offer cheaper valuations such as price/sales multiples, Peabody Energy has the financials to avoid liquidity risks. As an example, Peabody Energy trades at roughly 0.6x sales while Alpha Natural trades at only 0.2x sales. The substantial and continuous losses from Alpha Natural make that stock a very speculative investment. In the case of Peabody Energy, the company was recently profitable last year and faces an easier path to return to profitable operations.
For 2015, analysts forecast that Alpha Natural will again lose over $2 per share. Analysts only expect Peabody Energy to produce a small loss that could easily flip back into profits with a shift of regulations in the industry.
Miners of copper, fertilizer, and other commodities including the natural gas that is replacing coal trade at much higher multiples of sales.
The domestic coal mining stocks trade at some of the lowest price/sales multiples in the stock market. The multiple is definitely an indication of the weakness in the current market climate, but a shift in carbon regulations emphasis such as the one in Australia could provide a reprieve for the coal market. With further signs of coal supply taken out of the market and demand remaining strong, Peabody Energy is a solid buy at these levels.
Disclosure: The author is long ANR. 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.
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