R.I.P. Peabody Energy?
Judging by the stock market reaction (down ~18%) to Peabody Energy's, (NYSE:BTU) earnings, most specifically its 3rd quarter guidance, one wonders if the market is betting on a Peabody bankruptcy? Is Peabody a survivor, or are they destined to follow Patriot over the cliff? If Peabody is toast, can any U.S. coal producer survive the next 1-2 years of coal market Armageddon? Last question, rank the following from highest to lowest equity market cap: a) Ford, b) GM, c) Priceline.com, d) (the entire U.S. coal sector)?
The answer is 'd', the entire U.S. coal sector is ranked LAST with a combined market cap of ~$20-$21 billion. Peabody's earnings estimates are coming down. By one measure, consensus EBITDA looks like it might shake out at about $2.0 billion for next year, down close to 20% from pre-2nd quarter figures. On net debt of about $6 billion, that would be a debt/EBITDA ratio of 3.0x. However, as analysts have proven to have been too optimistic, let's assume next year's EBITDA will be $1.5 billion. Then, debt leverage would be ~4x, possibly prompting ratings agencies to put the Company's debt on negative watch.
Or, R.I.P Investors Who Are Shorting Peabody Stock at $20 Per Share?
As alarming as this may sound, Peabody is NOT headed towards bankruptcy. Costs and more importantly expansion cap-ex can be cut significantly next year. In the 2nd quarter, Peabody retired $240 million of debt at prices below par. Free cash flow would very likely remain flat to positive even on $1.5 billion of EBTIDA. Could EBITDA be much lower than that? Probably not, 70%-75% of U.S. coal production is contracted and priced. Australian thermal and coking coal sales contracts are wide open, but prices in the Pacific market appear to be stabilizing at recently low levels, ($200 for premium coking coal and $90 for thermal coal).
Interestingly, Peabody's U.S. operations and earnings contribution wasn't all that bad. The important negative surprises came from Australia. In fact, Peabody management was cautiously optimistic about a moderate rebound in the U.S. coal market in 2013 and pointed to a strong number of heating days in the west supporting Powder River Basin, "PRB" coal burn in the 2nd quarter and in July. This should help investor sentiment if nothing else. Cloud Peak, (NYSE:CLD), Alpha Natural Resources, (NYSE:ANR) and Arch Coal, (NYSE:ACI) are the other players in the PRB.
While it's nearly impossible to call a bottom on Peabody or any stock for that matter, now that the Company has set the bar much lower AND has ruined the 2nd quarter earnings season, a lot of bad news is probably priced in. Earnings estimates still need to come down a lot, but coal fundamentals have fallen so fast, that I'm getting the feeling that the bottom could now be a 2012 event instead of a 2013 event. If true, the market can start to think about 2013 being a trough year for earnings.
Continued Mixed Signals on Coal Fundamentals
Evidence of a bottom forming comes from multiple sources. Reports of producers in China, Russia, Australia and Indonesia cutting production have surfaced in just the last few weeks. Thailand's giant coal producer Banpu announced a 10% cut yesterday. While I've not yet heard of significant production cuts from Colombia, the strength of their currency is a big problem for them.
The good news is that Peabody is NOT going to file for bankruptcy protection. The bad news is that a turn in coal fundamentals will take time, possibly a year or more. I believe that coal stocks will rebound well before proof of a coal market recovery is firmly in place. Given the heavy volumes in Peabody stock this week, at least some investors appear to think that a stock price around $19-$20 per share is a defensible bottom.
Additional disclosure: I might go long Peabody via Call options in the next 72 hours.