Peabody Energy (BTU) Glenn L. Kellow on Q4 2015 Results - Earnings Call Transcript

| About: Peabody Energy (BTUUQ)

Peabody Energy Corp. (BTU) Q4 2015 Earnings Call February 11, 2016 11:00 AM ET

Executives

Victor P. Svec - SVP-Global Investor & Corporate Relations

Amy B. Schwetz - Executive Vice President and Chief Financial Officer

Glenn L. Kellow - President, Chief Executive Officer & Director

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Peabody Energy Fourth Quarter Earnings Call. For the conference, all the participant lines will be in a listen-only mode. As a reminder, today's call is being recorded.

I'll turn the conference over to Mr. Vic Svec, Senior Vice President, Global Investor and Corporate Communications.

Victor P. Svec - SVP-Global Investor & Corporate Relations

Good morning, and thanks for taking part in the conference call for BTU. With us today, our President and Chief Executive Officer, Glenn Kellow; and Executive Vice President and Chief Financial Officer, Amy Schwetz.

We do have some forward-looking statements today and I would remind you that 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 filed documents. And we also refer you to peabodyenergy.com for additional information.

Also please note that, given ongoing activities regarding our financial objectives, Peabody will not be conducting a Q&A session following our formal remarks. Should you have follow-up questions unrelated to these activities, please contact Peabody Investor Relations at, ir@peabodyenergy.com, following our call.

And with that, I'll now turn the call over to Amy.

Amy B. Schwetz - Executive Vice President and Chief Financial Officer

Thanks, Vic, and good morning, everyone.

In 2015, unprecedented commodity and coal market issues heavily weighed on our performance. At the same time, the Peabody team improved safety and substantially lowered costs and capital. We are also pursuing aggressive actions to preserve liquidity and delever our balance sheet. I'll start by discussing the 2015 results, then review our liquidity position, and conclude with an update of our 2016 guidance.

Let's begin with a review of the income statement. 2015 revenues of $5.6 billion declined 17%, impacted by lower realized pricing in both the U.S. and Australia as well as an 8% reduction in sales volumes. Adjusted EBITDA totaled $435 million in 2015 compared to $814 million in the prior year. The team was able to claw back some $620 million through lower costs in both the U.S. and Australia. However, that was unable to offset over $450 million in lower pricing and $387 million in additional realized hedge losses.

In the fourth quarter, Peabody took a $377 million impairment charge. As you may recall that earlier in the year we took $900 million in charges, bringing the total impairment for the year to $1.28 billion, primarily related to lower coal prices. Specific to the fourth quarter charge, $251 million related to the Australian Metallurgical Mining operations and $126 million related to our reserve position in the Midwest.

Interest expense was $533 million in 2015, and includes nearly $68 million of early extinguishment losses from refinancing of our 2016 Senior Notes in the first half of the year.

Continuing down the income statement, full-year taxes reflect a benefit of $135 million compared to prior-year expense of $201 million. The $336 million improvement is driven by a $75 million benefit related to asset impairments and a valuation allowance of nearly $285 million recorded against U.S. income taxes in 2014.

Loss from continuing operations totaled $1.85 billion, including $1.2 billion from asset impairments, net of income taxes. Diluted loss per share from continuing operations totaled nearly $103 and adjusted diluted loss per share totaled $36.39. I'll remind you that both those numbers have been adjusted for the 1-for-15 reverse stock split that took place in October. Discontinued operations reflect a loss of $182 million for the year. As you'll recall from last quarter, this is primarily due to the third quarter charge we recorded for certain Patriot liability.

I'd like to now briefly touch on the fourth quarter results. Adjusted EBITDA of $53 million reflects several changes from the third quarter. Trading results declined $33 million from the segment's strong third quarter operating performance. As we noted on the call in October, we expected Trading results to return to normalized levels. U.S. Mining operations fell $22 million primarily as a result of lower volumes in the Midwest and the West. Australian Mining operations declined $10 million primarily due to lower pricing. While within our guidance range, SG&A increased $10 million largely due to professional fees for a number of business development and financing transactions, both completed and contemplated.

And finally, other operating costs increased $18 million due primarily to $14 million charge associated with Peabody assigning a portion of our Australian port capacity to another producer. Partially offsetting these impacts, Peabody had additional gains of $17 (sic) [$70] million related to ongoing activities as we continue to sell surplus land and reserves.

Now let's turn to the supplemental information for the full year. U.S. Mining adjusted EBITDA decreased $146 million in 2015, reflecting sharply lower volumes across the platform, with shipments down 25% in the West and 15% in the Midwest. Even with reduced volumes, costs per ton improved 5%, driven by a higher PRB mix, lower fuel pricing, and continued focus on cost improvements. In the PRB, subdued natural gas prices and higher customer stockpiles drove a nearly 4 million ton reduction in volume from our expectations, with a significant portion of that coming very late in the quarter. Given that we were fully committed in 2015, many of these reductions were deferred into later periods.

In the Midwest, gross margins rose 3% even with lower volumes as favorable fuel pricing and other measures resulted in more than a $2 per ton improvement in costs. Western shipments declined 6 million tons in 2015 with nearly half of the decrease due to a planned reduction in exports and the remainder due to lower customer deliveries from weak natural gas prices. The higher fixed cost allocation resulted in 4% higher unit cost.

Turning to Australia, 2015 adjusted EBITDA increased $62 million to $175 million, an impressive feat in face of lower volumes and a $420 million impact from lower pricing. Favorable currency and fuel costs combined with productivity improvements to overcome the challenging market conditions.

Metallurgical coal volumes declined 1.5 million tons, primarily due to production cuts announced during the second quarter, a planned reduction at the contractor-operated Burton Mine, and the closure of the Eaglefield Mine in late 2014. Despite reduced shipments and lower realized pricing, gross margins improved as a result of $26 decline in unit costs. The operations had $115 million in cost improvement, independent of currency and fuel. This performance came despite $40 million of negative adjusted EBITDA at the contractor-operated Burton Mine. You will recall that we resectored this long-term contract for greater flexibility in 2014, and we expect to place the mine in care and maintenance mode during the end of 2016.

The Thermal segment also continues to benefit from the declining Australian dollar and lower fuel costs. However, these savings were not enough to offset $9 per ton in lower pricing and shipments.

Full-year Trading and Brokerage adjusted EBITDA increased $12 million to $27 million, despite a 5 million ton volume reduction. Results included favorable positions settled during the year, and a $7 million gain related to a negotiated settlement in the third quarter. Realized corporate hedge losses, primarily driven by currency, totaled $437 million for the year. These positions continue to roll off as we do not have any currency or fuel hedges past 2017.

Consistent with prior quarters, we have included a summary of our hedge position in the supplemental schedule, highlighting our lower fuel and currency requirements, and all-in forward rates. It has not gone unnoticed by the new team that our adjusted EBITDA would have offset the impact of lower pricing and, in fact, would have been higher than 2014, if not for the increased hedging losses.

With that review of the income statement and earnings drivers, let's turn to our liquidity position. Peabody ended the year with $1.2 billion of liquidity, and about $710 million in letters of credit. In 2015, our liquidity was impacted by providing credit support to financial institutions, nearly $400 million in cash interest payments, $277 million in PRB reserve installments, lower cash from operations, and a $75 million VEBA payment.

Recently, the company accessed the remaining capacity under its revolving credit facility to provide Peabody with the maximum amount of control and flexibility with respect to its liquidity positions in light of continued challenging market conditions. As of February 9, 2016, liquidity totaled about $900 million consisting nearly all of cash. The company also had approximately $825 million in letters of credit issued primarily off our revolver, supporting surety bonds, bank guarantees, and other obligations. We had approximately $514 million of surety bonds outstanding, for which we have posted $160 million of letters of credit or 30% of the total amount. I will note that while we have had discussions with our providers, the amount of collateral under these bilateral agreements can change.

We had approximately $390 million of bank guarantees outstanding and have collateralized over 95% of these obligations. And we had approximately $290 million in letters of credit for other obligations, such as port agreements and pension, most of which have been in place for some time. We are focused on preserving liquidity and reducing debt, which remain our top financial priorities in 2016. I would also add that, in the fourth quarter, Peabody self-bonding was affirmed for our North Antelope Rochelle and Rawhide Mines in the PRB.

Looking forward, Peabody has several cash obligations that expire or materially decline in the next two years. First, we are scheduled to complete the last committed annual PRB reserve installment of $250 million late this year, which provides us with a competitive advantage in the region. As you may recall, we were awarded these leases in late 2012 following a competitive bidding auction. Second, we continue to see a benefit in hedge realizations each quarter as the year progresses, and at current rates, realized 2016 hedge losses would be approximately $100 million lower than 2015 and even lower in 2017. Third, our recently announced amended agreement with the UMWA regarding the VEBA trust fund improves 2017 cash flows by $70 million. And finally, we proactively assigned excess Australian port capacity to another producer, which is expected to reduce infrastructure costs by more than $60 million through 2020.

In addition, Peabody recently amended contracts to reduce certain U.S. transportation and logistics costs expected to be due in early 2017. In connection with these amendments, Peabody will realize a net reduction of $45 million in estimated liquidated damage payments that otherwise would have come due in early 2017.

With respect to the collateral package under the secured credit facilities, total consolidated net tangible assets were $9.5 billion at the end of the year, with $3.4 billion in principal property and $1.7 billion in non-principal property.

Under the credit agreement, compliance is also an area of interest. And I would point out that our reported adjusted EBITDA differs from the terms used for calculating compliance in the credit agreement. For example, the adjustments may include, in certain instances, cash proceeds from asset monetization activities. As a reminder, our credit agreement financial covenants include a minimum one-to-one interest coverage ratio and a maximum 4.5 times net secured leverage ratio.

Turning to our 2016 outlook, first quarter results will include a gain of approximately $70 million from the UMWA settlement. Compared with the fourth quarter, we are expecting lower first quarter results for Mining segments due to long haul moves in Australia and Colorado, lower realized pricing and volumes, and expect hedge realizations to improve as the year proceeds.

For full-year 2016, we expect decreased volumes across the platform, challenged prices and a continued cost emphasis. Full-year financial targets include the following. Reducing our U.S. sales volume targets by 18 million tons to 28 million tons from 2015 levels. We are now fully priced in 2016 as we eliminated all uncommitted production in response to market conditions. Our fully priced 2016 sales position includes 116 million tons of PRB priced at an average of $13.30 per ton.

U.S. revenue and cost per ton targets were sensitive to a change in mix from expected lower PRB volumes and reduced fuel expense. We are pleased to be stabilizing costs given the impact of the current production mix and significantly lower planned volume levels. We are reducing Australian Met volume to 14 million tons to 15 million tons after taking into account the production cutbacks and cost improvement efforts made last year.

Even with reduced volumes, we are lowering our overall Australian cost per ton range to $45 per ton to $48 per ton to reflect the benefit of declining currency and fuel expense, and ongoing cost containment efforts. In addition, we are reducing SG&A expense another 12% to 18% to $145 million to $155 million as we expect to realize a full-year benefit of the steps we took in the second quarter of 2015 to streamline and delayer the organization. And finally, we are lowering CapEx to $120 million to $140 million with a focus on safety initiatives and sustaining lower production levels as we continue to benefit from a relatively younger set of equipment.

That's a brief review of our 2015 performance and our 2016 outlook. Now I'll turn the call over to Glenn.

Glenn L. Kellow - President, Chief Executive Officer & Director

Thanks, Amy, and good morning, everyone.

It is clear as we look at Peabody's position against the industry backdrop that we actually face two stark contrasts. On the one hand, we have the punishing effects of depressed commodity markets on earnings, cash flow, and securities prices as we travel through some of the darkest days of the downturn. On the other hand, early last year, we outlined four areas of emphasis and our entire workforce delivered everything that was asked of them. We drove significant improvements in costs and CapEx management, implemented a leaner organization, and advanced multiple work streams to shape the portfolio and advance our financial objectives.

Above all of our efforts, I'm pleased to note that, in 2015, our team achieved the best global safety incidence rate in our 133-year history, a 13% improvement over our previous best in 2014. The bottom line, though, is that we realize that while we took two steps forward in the past year, market headwinds have pushed us three steps back. Even with as much progress as we made in 2015, significantly more needs to be done. Today, I'll discuss the key advancements across the platform and highlight our core priorities for 2016 as the team takes further action in what already is another challenging year.

Let's first look at current market dynamics. During the past year, sluggish global economic growth drove a broad collapse in commodity pricing both in energy and mining sectors. Despite acceleration in supply cutbacks, seaborne coal prices continue to wane amid a sharp decline in coal demand. And in the U.S., a weaker energy market, mild weather, and surplus natural gas with the lower prices and reduced coal consumption. China continued to be the primary driver for macro concerns as the country's annual GDP fell to the lowest pace in 25 years with steel and energy-intensive sectors impacted disproportionately. As a result, domestic steel demand declined last year, which pushed China's steel exports to a record of over 110 million tons in 2015. The dramatic rise in China's steel and coke competition in turn affected other steel production and impacted demand in seaborne metallurgical coal in other regions. Seaborne metallurgical coal quarterly settlements declined some 30% over the past year.

Also in 2015, seaborne thermal coal prices fell to multi-year lows on reduced European demand and a nearly 75 million ton decline in China's imports. As expected, seaborne met coal shipments fell below 300 million tons in 2015 with exports declining from the U.S. and Canada in the back half of the year. While Australian exports are projected to increase slightly in 2016, we project further reductions from the U.S. to offset this growth, leading to an easing in overall seaborne supply.

We are seeing similar trends unfold in seaborne thermal coal markets as weaker demand led to supply rationalization, primarily in the U.S. and Indonesia. And we expect to see further supply reductions from the U.S. producers facing greater pressure from lower pricing.

We've recently seen some trends throughout the supply/demand balance; China is taking steps to reduce overcapacity in domestic steel and coal production, China's declining PMI numbers showed signs of stabilizing, and India is beginning to fill part of the void as the fastest-growing large economy. Still, there is no question as we review the global markets that these positive indicators are overshadowed by near-term concerns.

Looking now to the U.S. coal market, 2015 U.S. coal demand fell approximately 110 million tons, a drop that exceeded our third quarter estimates due to mild weather and a steady decline in natural gas prices, which hit seasonal lows including spot prices below $2 in December, levels not seen since the early 2000s. As a result, coal declined to 34% of U.S. electricity compared to 40% in the prior year. Natural gas remained the primary beneficiary, representing 31% of total generation. Low natural gas prices also kept capacity utilization and coal fuel generation at modest levels averaging 55%. At the same time, reduced coal demand led to an elevated utility inventory build that reached a record high by year end. And in response, U.S. coal supply declined more than 100 million tons with cutbacks accelerating in the fourth quarter.

You will recall that, in our estimates, PRB coal remains economic even with $2.50 to $2.75 natural gas prices and compares favorably to the Illinois Basin with a delivered cost of $3.50 to $3.75, and Central Appalachia to the $4.00 to $4.50 range per mmBtu. This offers a sign of how economics would improve in an environment where natural gas prices are expected to increase over time. Demonstrating the competitive position of our portfolio, Peabody represented only 9% of the overall decline in supply in the fourth quarter, even as we accounted for approximately 20% of all U.S. coal production last year.

We regard our PRB portfolio as second to none. We have more than 25 years of production, and our reserves are located on the right side of the joint line. This represents long-term security of supply and an advantage over competitors in this region. Nonetheless, we believe that the Administration's recent actions regarding review of the federal coal leasing program represents poor policy and a flawed way to accomplish environmental goals.

As I mentioned, in the third quarter, we expect 2016 coal demand by utilities to fall below 2015 levels, now projected at around 40 million tons to 60 million tons, assuming lower natural gas prices, and projected plant retirements. We anticipate decreased U.S. production of 150 million tons to 170 million tons in response to lower use, significant utility destocking, and reduced exports. In fact, nearly 20% of that expected reduction looks to have taken place in January alone based on industry shipment data.

In response, Peabody is lowering our U.S. volume targets by 10% to 15% to a level consistent with customer commitments, as we believe there will be very limited opportunities to sell uncommitted volume. We plan to continue to work with our customers to match supply with demand in this market, and look to preserve contract value.

We also continue to modify our production plans based on market needs. I would note the recent reduction of 75 positions at our Midwest Arclar Complex, and we are currently leveraging our flexibility in our three mine position in the PRB, but being able to redeploy employees, equipment, and contracts to maximize cash and margins.

Our strategic focus on coal regions gives us the ability to manage basins as portfolios as opposed to individual mines. And, whilst we fully expect 2016 to be another trying year for the U.S. coal industry, we continue to believe that our leading positions in the lowest-cost basins will best position us to benefit from any rise in natural gas prices and coal demand over time.

With that overview of the coal markets, I'd now like to discuss our priorities for 2016 as we build upon previous successes across the organization. First, we will strive to continuous improvement in safety, productivity, and costs across the platform. Safety is our first value. And, as I've mentioned, 2015 was the safest year in Peabody's history in terms of reportable incidents.

At the mine level, we saw strong underlying performance with lower unit costs despite lower volumes, which is a credit to each of our mines and their teams. Operating costs declined sharply in both the U.S. and Australia and gross margins across four of our five operating segments averaged 26%. At the same time, both capital spending and SG&A were reduced to the lowest level in nearly a decade as we completed initiatives to delayer and streamline the organization.

Our second core priority is to preserve liquidity and reduce debt. As you know, we have been pursuing multiple actions for some time as part of our new financial objectives. Along with our advisors, we've engaged in discussions with holders of several tranches of our debt to evaluate potential financial alternatives to preserve liquidity and delever the balance sheet. These discussions are towards several ends. We seek to reduce interest expense, which in 2015 was the largest part of our fixed charges. Capture discount based on the levels of our public debt prices and extend maturities to offer a greater runway toward longer term improvements in the coal markets.

As you have seen, we've explored new debt instruments, including potential debt exchanges, debt buybacks, and new financing. We recognize that these are complex challenges, particularly given the volatility in the coal and capital markets. While no agreements have been reached at this time, we expect to continue discussions with debt holders where appropriate. We will give strong consideration to elements that include economics, runway, interest expense, and timing.

There is no doubt our debt and equity are trading at distressed levels, which is indicative of the headwinds the industry is facing. You may recall last quarter that I noted it was as important to enact the right deal as a quick deal and unfortunately the continued deterioration in the capital markets validated this. But this remains the absolute financial priority of the corporation. Given the sensitive timing of this call relative to activities that are underway, we cannot provide further details on these strategies at this time. We do intend to continue to update as appropriate.

Our third core priority is to continue to shape our portfolio to unlock value. In 2015 the company realized cash proceeds of $70 million related to ongoing resource management activities through the sale of surplus land and coal reserves. In the fourth quarter, we announced the planned sale of our New Mexico and Colorado assets for $358 million and the purchaser is currently arranging financing.

In addition, Peabody recently announced plans to sell our 5% interest in the Prairie State Energy Campus for $57 million. Prairie State represents some of the cleanest and lowest-cost coal fuel generation in the company. It also represents a good example of us monetizing non-core assets to pull forward cash for liquidity or debt reduction purposes. We will continue to evaluate such transactions based on strategic fit, value considerations, potential growth, and cash requirements.

There is no question that the industry backdrop has been challenging. Not to mention the fact that several of our peers have filed for bankruptcy in the last year. Peabody is not immune to these external pressures as evidenced by our earnings, cash flows, and pricing of our public instruments. That doesn't change, though, the underlying strength of a platform that continues to excel on many levels.

Peabody has an unmatched asset base, operated by the best workforce in the industry. We have made tremendous advancements to mitigate the impacts of declining markets through cost saving initiatives, organizational improvements, and portfolio optimization efforts. And we recognize that we have much more to do in 2016 as we take the necessary steps to maintain competitiveness, preserve liquidity, and delever our balance sheet.

With that, I would like to thank everyone for joining our call this morning and extend my appreciation to the entire Peabody team for your extensive efforts in the face of some very challenging market conditions.

As we've noted, we will not be hosting a Q&A session given the fluid status of our ongoing liability management activities. We will continue to keep you apprised of our actions through appropriate disclosures as our progress advances.

Thank you for your interest in BTU. And, John, that concludes our call.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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