Peabody Energy (NYSE:BTU) is the world's largest private coal company. The coal miner has majority interests in 26 coal operations located throughout all major coal producing regions in the United States and Australia. Moreover, it owns the North Antelope Rochelle mine located Wyoming. It is the largest coal mine. This one single mine produces approximately 12% of the America's coal. On a daily basis, 21 trains composed of 132 cars each are filled with the coal produced from the North Antelope Rochelle mine.
In my opinion, Peabody Energy owns the best coal mines in the world. Moreover, it is probably the most diversified player in the U.S with its operations in Australia. The problem does not reside in these aspects. The problem is its overleveraged balance sheet. The decent operating margin is dilapidated by the expenses associated with the debt load. In my opinion, the bankruptcy seems extremely probable.
This affirmation is corroborated by the credit analyst. As of January 14, the unsecured bonds are trading at 8.6 cents on the dollar for an impressive yield of 99%. The bankruptcy looks already priced-in. With the recent bankruptcy of Arch Coal, the sector's default rate stand at an unprecedented peak of 43%.
Over the last few years, 26 coal companies have gone bankrupt. Walter Energy, Alpha Natural Resources, Patriot Coal and Arch Coal are probably the best-known victims of the prolonged downturn. Consequently, 264 mines have closed according to the magazine OnEarth.
As Rick Rule said, you must be a contrarian or you will be a victim in the natural resources space. The numerous acquisition made at the top of the cycle back in 2011 were clearly not contrarian. Now, the coal companies are feeling the pain and they are victims. On the supply side, it is important to mention that many mines continue to operate during the restructuring progress under the Chapter 11. It significantly delays the production cuts.
With a market capitalization of $80 million and $6.3 billion in debt, the game is almost over for Peabody Energy. The following table illustrates this situation.
Over the last four quarters, the firm generated $5.98 billion in revenue and the cost of the revenue was equal to $5.18 billion. Indeed, it is possible to calculate a gross profit of $805 million. It is important to remember that the gross profit only considers the variable costs associated with the operations. Indeed, it does not include variables like rent, insurance or salaries for employees not involved directly in the production chain for example.
On the other side, the interest expense generated by the debt load is extremely high. On a trailing twelve month basis, the interest expense metric is equal to $452 million. In other words, the interest expense represents 56.14% of the gross profit. Furthermore, the operating income is negative by $1.2 billion over the last four quarters. How is it possible for Peabody Energy to pay $6.3 billion in principal if the gross profit is barely sufficient to cover the interest expense? The debt exchange might be the solution. However, this avenue failed for Arch Coal.
Finally, the time variable becomes increasingly important. In fact, the coal miner is burning cash quarter after quarter. The bomb is ticking and the time horizon to find a solution becomes shorter and shorter. Over the last four quarters, the operating cash flow figure is positive by only $32 million and the investing cash flow metric is negative by $371 million. So, the corporation is burning $339 million per year based on the current market conditions.
Currently, it has $334 million in cash and cash equivalent. If we add $57 million for the Prairie State Energy Campus sale and $358 million for the New Mexico and Colorado sale, it is possible to conclude that Peabody has $750 million in its bank account. Nevertheless, Arch Coal went bankrupt even with almost $700 million in cash. The situation was similar for Alpha Natural Resources.
There are two possible scenarios the avoid this terrible outcome. The first scenario is to finalize the debt exchange agreement. This scenario did not work for the other coal producers. The second scenario is to continue to sell a meaningful amount of assets at a distressed price. Based on the atmosphere in the coal industry, the totality of its assets is probably not worth the principal of $6.3 billion in my opinion.
In conclusion, the bankruptcy looks inevitable in my opinion. I believe the asset sales are only buying time and not solving the real problem. I would not touch the stock with a ten-feet pole. In few years, the coal sector will become interesting for a bargain hunter like me. In a previous article, I briefly explained why I am bullish on Alliance Resources Partner (NASDAQ:ARLP). I would not buy any coal stock at the moment. Because of the substantial short interest, I would not short Peabody Energy due to the short squeeze risk.
I am an undergraduate student, not a professional. Please take this factor into consideration. Please do your due diligence and consult your financial advisor before taking any action. I am not a financial advisor. This article expresses my opinion only.
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