Peabody Energy Corporation (BTU): New Analyst Report from Zacks Equity Research - Zacks Equity Research Report

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Summary:
Peabody Energy's loss per share in the second quarter was marginally wider than expected. Overall improvement in sales volumes and higher realized prices of U.S. tons sold helped the company to beat the top-line estimate. Peabody expects a revival in thermal coal demand globally, led by continuous urbanization and industrialization in China and India. The projection of the World Steel Association indicates an improvement in met coal sales driven by higher steel consumption. However, the new Clean Power Plan of the U.S. EPA and expected railroad service congestion in the second half might impact the prospects of the company. Hence, we have retained our Neutral recommendation on the stock.

Overview:

St. Louis, MS. based Peabody Energy Corporation is the world's largest private sector coal mining company, owning majority interests in 27 mines in the U.S. and Australia and a 50% equity interest in the Middlemount Mine in Australia. As of Dec 31, 2013, Peabody had proven and probable coal reserves of 8.3 billion tons, of which 7.3 billion tons were in the U.S. and the rest in Australia.

Peabody conducts its business through four principal operating segments: Western U.S. Mining, Midwestern U.S. Mining, Australian Mining and Trading & Brokerage. The principal business of the Western U.S. Mining segment is surface mining and sale of low sulfur, low British thermal unit (Btu), bituminous and sub-bituminous coal to electric utilities. Western coal requires higher transportation costs due to longer shipping distances, though several railroads have announced multi-million dollar capital programs to bring improved transportation to the area. The Midwestern U.S. Mining segment extracts bituminous coal deposits primarily from underground mines in the Illinois Basin that produce high-sulfur, high-Btu coal. Australian Mining operations are characterized by both surface and underground extraction processes, mining primarily low-sulfur and high-Btu thermal and metallurgical coal that is primarily sold to an international customer base. The Trading & Brokerage segment engages in brokerage operations for and on behalf of other coal producers and the trading of coal, freight and freight-related contracts.

Peabody's fifth segment, Corporate and Other, includes mining and export/transportation joint ventures, energy-related commercial activities, as well as the management of vast coal reserve and real estate holdings.

In 2013, mining operations accounted for about 98% of the company's revenues. Peabody's Western U.S. Mining operations form the lion's share of its reserve base and yearly sales (63% of 2013 sales). The Australian Mining segment is the most profitable division of the company due to its favorable geological characteristics and proximity to high demand regions. In 2013, Peabody sold 251.7 million tons of coal, with total revenue coming in at $7.01 billion.

Source: Company

REASON TO BUY

Peabody Energy has a competitive advantage due to its Australian platform, which offers greater access to emerging Asian economies such as China and India. In addition, Japan and South Korea import a substantial volume of Peabody's coal. Australia, by virtue of its location, is uniquely positioned to service Asian coal demand. Aiming to capture the growing coal demand in the Asian markets, Peabody further expanded its footprint in Australia through the acquisition of the Macarthur coal mines. This acquisition enhances Peabody's presence in the highest-growth coal markets in the Pacific basin with quality metallurgical coal from the acquired mines. Leveraging these assets, the company is aiming for higher shipments from Australia and targets metallurgical coal sales of 16 to 17 million tons and seaborne thermal coal sales of 11 to 12 million tons in 2014. Total Australian coal sales are expected to range from 35 million to 37 million tons in 2014. Peabody expects 2014 sales to be in the range of 245 million to 265 million tons, with 185 million to 195 million tons coming from U.S. sales.

The International Energy Agency ("IEA") estimates that worldwide electricity demand will increase by two-thirds between 2011 and 2035. As per IEA, coal will continue to have the largest share in the global power generation mix albeit falling to 33% in 2035 from 41% in 2011. Coal will continue to command the largest fuel share in worldwide electric power production China and India are expected to account for 75% of the rise in demand for coal in the aforementioned period. Japan is also importing a large volume of thermal coal to compensate for the loss in power production from nuclear sources. In spite of a preference for renewables, the demand for coal in the period 2009-2035 would still far exceed other sources of power generation. China is planning to shut down over 1,700 smaller mines with nearly 120 million tonnes of capacity in 2014 to phase out low-quality coal production from its system. This will create new avenues for Peabody's coal export. Moreover, as per a report from World Steel Association, global steel usage is expected to increase by 3.1% in 2014 from 2013 levels. Since metallurgical coal plays a vital role in steel generation, the demand for met coal is also expected to increase. The projected increase in demand for both thermal and met coal in the global markets will benefit the company, as it currently supplies coal to more than 25 countries in 6 continents.

In the U.S., Peabody Energy has a large production and reserve position in the two fastest growing coal markets: the Powder River Basin (PRB) and Illinois Basin. It also has leading positions in Colorado and the southwest United States. Going forward, Peabody expects to benefit from its PRB and Illinois Basin assets, which are safe, low-cost regions that will continue to penetrate the Eastern U.S. markets. Typically, around 93% of the coal generated in the U.S. is used for power generation. As per U.S. Energy Information Administration (EIA) coal will hold a share of over 40% of U.S. electric power generation in 2014. Per an EIA report, U.S. coal production in 2014 will increase by 4.4% year over year to 1,028 million short tons (MMst). EIA projects 2014 coal consumption to reach 971 MMst, reflecting 5% growth from 2013 levels. The projected increase in coal usage in the U.S. is attributable to higher demand for electricity and the rising cost of natural gas. Peabody with its presence in these two coal markets is set to benefit from the increase in coal demand.

Strong cost containment efforts and capital discipline are helping the company amid the prevailing supply glut in the majority of global coal markets. Financial discipline allowed the company to exit first quarter 2014 with $508.1 million of cash in hand. Peabody refinanced its credit facility taking advantage of the prevailing market conditions. The refinancing included a five-year revolver, which expanded to $1.65 billion and a seven-year $1.2 billion term loan. The refinancing replaced the company's $1.5 billion revolver and $1.2 billion of term loans, which were due in 2015 and 2016 respectively. The increased financial flexibility will allow the company to utilize the funds in new business ventures.

Peabody's growing presence in Indonesia and Mongolia will allow it to cater to the increasing demand in the Asia Pacific region. Mongolia is touted to have one of the best untapped coal resources in the world, which will benefit from Peabody s coal mining expertise. Peabody Energy recently entered into an agreement with China s Shenhua Group to create Sino-Pacific Coal Trading Corporation Pte. Ltd. The primary objective of this Singapore based corporation will be to meet Shenhua s coal demand from Peabody's global coal production platform. The company will most likely leverage its existing platform in these regions to cater to most of Shenhua Group's demand.


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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Referenced Stocks: PRB , EIA , BTU

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