- Initial forecast calls for 12 million tons to 13 million tons in Australian thermal coal shipments and 14 million to 15 million tons of Australian metallurgical coal sales.
- Expected U.S. thermal coal production already sold under contracts, limiting exposure to price weakness after unseasonably mild winter.
- Has placed Wilkie Creek Mine in southeast Queensland on sales block to reduce debt incurred from acquisition of Macarthur Coal.
- Management warns that 2012 will be a year of transition for Peabody Energy, as operational mines acquired from Macarthur Coal will require significant investment to upgrade equipment and remove waste rock.
- Management's guidance calls for first-quarter earnings per share of $0.50 to $0.75, well below analysts' consensus estimate prior to the call.
After surging 42 percent in 2010, shares of Peabody Energy Corp (BTU) gave back these gains in 2011, hit by uncertainty surrounding steel production and economic growth in China and other key emerging markets.
Despite these worries, Peabody Energy Corp still managed to report record full-year results, including revenue of $7.97 billion (up 18 percent) and earnings before interest, taxes, depreciation and amortization (EBITDA) of $2.13 billion (up 15.7 percent).
After weather-related disruptions in early 2011 and equipment moves and a roof fall at its North Goonyella mine in the third and fourth quarter, the company's Australian operations (36 percent of 2011 revenue) shipped 25.3 million tons of coal-down slightly from 27 million tons in 2010. This total included 9.3 million tons of metallurgical (MET) coal, the varietal used in steel making, and 10.1 million tons of seaborne thermal coal, the varietal burned at power plants.
Nevertheless, strong pricing in 2011 for both met and thermal coal enabled Peabody Energy's Australian concerns to grow their revenue by 28 percent from a year ago, while a 26 percent improvement in margins led to a 22 percent surge in EBITDA.
The firm's U.S. operations (55 percent of 2011 revenue), which are located primarily in the low-cost Powder River Basin and the Illinois Basin, enjoyed a 5 percent uptick in coal shipments during the year, largely because of a record 109 million tons of low-sulfur coal output from the North Antelope Rochelle Mine in Wyoming.
During a conference call to discuss fourth-quarter earnings, Peabody Energy CEO Gregory Boyce indicated that the company expects the "two-speed global economy" to continue in 2012, with emerging markets such as China, India and Brazil leading the way and the developed world posting subpar growth.
Outlook for Seaborne Thermal Coal
Peabody Energy expects global demand for seaborne thermal coal to increase by 5 percent to 10 percent in 2012, led by China and India. Accordingly, management estimates that the firm's shipments of Australian thermal coal will increase to between 12 and 13 million tons, from 10.1 million tons in 2011. About 40 percent to 50 percent of Peabody Energy's expected 2012 Australian thermal-coal sales are covered by contract, providing ample exposure to any potential upside in prices.
The long-term growth story in seaborne thermal coal also remains attractive.
As the quintessential emerging market, China's appetite for thermal and metallurgical coal receives a lot of attention from investors and commentators.
The mainland's utilities built up their winter inventories of thermal coal ahead of schedule in 2011, amassing a record 81.5 million metric tons (21 days' worth of consumption) in November. Some of this record inventory stems from an uptick in domestic output-government-mandated consolidation in the industry has improved productivity-but looser credit requirements on the part of domestic suppliers also factor into the equation. Meanwhile, relatively mild weather has suppressed demand relative to previous years.
Nevertheless, the Mainland's thermal-coal imports are expected to increase consistently over the next several years because of rising electricity demand and insufficient rail capacity to transport output from coal-producing provinces in western China to end markets in eastern and southern China. These logistical bottlenecks, coupled with rising wages and production costs, increase the price competitiveness of imported coal.
In November 2011, the National Development and Reform Commission instituted a ceiling on coal prices in an effort to limit losses related to rising coal prices and regulated electricity prices. Previous efforts of this nature, which addressed the domestic market and failed to account for global supply and demand factors, have failed; I expect this latest attempt to suffer the same fate.
In short, I remain bullish on China's long-term demand for seaborne thermal coal. The country's electricity consumption increased by more than 10 percent in 2011. With China expected to build 250 gigawatts of coal-fired generation capacity between 2011 and 2015, imports should increase in coming years. Coal from Australia will be a big part of this story, and Peabody Energy will be a leading supplier.
Meanwhile, Indian demand for thermal coal will likely outstrip Chinese demand over the next decade. Domestic coal production has lagged the growth targets laid out by India's Planning Commission in the current five-year economic plan. Much of this shortfall reflects the operational difficulties facing Coal India, which produces 78 percent of the nation's domestic coal supply, and has struggled to ramp up production. Some of these challenges relate to difficulties obtaining mining permits and acquiring land in the densely populated nation.
All of this adds up to a massive supply shortfall that must be offset by expensive imports, primarily from Australia and Indonesia. In the fiscal year ending March 31, 2012, the gap between domestic supply and demand should reach 142 million metric tons and will only continue to expand. In 2011 India's imports of thermal coal surged 35 percent from year-ago levels, to about 85 million tons.
With its extensive production platform in Australia, Peabody Energy is well-positioned to supply utilities in India and China with thermal coal. By 2015, the company expects to expand its annual thermal-coal production in Australia to between 15 and 17 million tons.
However, the near-term outlook for the U.S. thermal coal market is less sanguine. The supply-demand balance has deteriorated in recent months, as an unseasonably warm winter has combined with sluggish economic growth to increase utilities' coal inventories. With power companies seeking to curtail deliveries or sell excess supplies into an already thin market, U.S. thermal coal prices have come under pressure.
Meanwhile, depressed natural gas prices and efforts to reduce carbon dioxide emissions continue to prompt some utilities to switch to gas from coal. Rick Navarre, Peabody Energy's chief commercial officer, told analysts that the company expects fuel replacement among U.S. power companies to eliminate between 35 and 40 million tons of coal demand in 2012, largely from mines in Central Appalachia.
After spinning off its assets in Central Appalachia, Northern Appalachia and less desirable parts of the Illinois Basin in 2007, Peabody Energy has little exposure to rising production and regulatory costs in these mature mines.
Today, the company operates primarily in Wyoming's Powder River Basin, which contains thick seams of low-sulfur coal that are relatively easy and inexpensive to mine, and the Illinois Basin, another low-cost region that produces coal with higher sulfur content. With many plants scheduled to have advanced scrubbers installed over the next few years, the addressable market for Illinois Basin coal is growing rapidly.
In addition to its low cost base, management's prescient decision to sell the firm's planned 2012 production under contracts will insulate earnings from the recent deterioration in prices. The firm has 45 percent to 55 percent of its planned 2013 production priced under contracts. These moves, coupled with the company's extensive operations in Australia, give the firm a leg up on US-based competitors.
Outlook for Met Coal
Rising demand for met coal in China, India, Brazil and other emerging markets will drive much of Peabody Energy's earnings upside in coming years. Management currently expects seaborne volumes of met coal to increase by 10 percent to 15 percent in 2012, spurred by a 5 percent uptick in global steel demand. The company aims to sell between 14 and 15 million tons of metallurgical coal in 2012. Almost all the firm's expected 2012 output hasn't been priced under supply contracts; the company could enjoy a lucrative year if met coal prices stabilize and move higher.
The long-term supply and demand picture for met coal is more bullish. Peabody Energy estimates that urbanization in China, India and other emerging markets will increase global demand for met coal at an average annualized rate of 5 percent over the next eight years. With an ambitious slate of organic expansion projects, Peabody Energy expects its Australian operations to produce between 22 million and 25 million tons of met coal annually by 2015.
I also like the company's focus on metallurgical coals that tend to command a premium price: Management estimates that hard coking coal will account for 40 percent to 50 percent of the firm's 2015 Australian met coal production, while low-volatility pulverized coal injections (LV PCI) are expected to account for 30 percent to 35 percent. This type of coal is crushed into a fine powder and injected into blast furnaces as a partial replacement for met coal in the production of pig iron.
Peabody Energy is the world's largest pure-play coal producer with operations in Australia and the western U.S. and remains a strong long-term bet on rising coal demand in Asian markets and other emerging economies. For investors with a longer horizon, the stock trades at an attractive valuation.
That being said, the stock lacks near-term catalysts and could pull back if economic growth and steel production in China disappoint. Pricing trends on met coal volumes should become clearer during the second quarter.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.