BTU - Peabody Energy: A Blowout Q4 And Impending Capital Returns

Summary

• Peabody Energy reported impressive Q4 earnings on Tuesday morning and shares responded by ripping 13% higher.
• They repaid all the secured debt in 2022 and ended the year with $1.3B in cash on the balance sheet.
• The market cap sits at $3.8B and the company did $1.2B in operating cash flow in 2022.
• It's only a matter of time before the company deals with the reclamation surety agreement and the floodgates open on buybacks and dividends.
• Shares are dirt cheap today and I expect they will be trading much higher in the next year or two.

Over the last couple months, I have been putting money to work in the parts of the energy sector where I think there is asymmetry due to a disconnect between share prices and the actual value of some parts of the energy sector. I have written articles about offshore companies like Transocean ( RIG ) and Tidewater ( TDW ), and I think both stocks will provide attractive returns for investors in the next couple years. Another stock that I think has an asymmetric risk/reward profile is Peabody Energy ( BTU ). The company reported year-end earnings on Tuesday morning, and there is a lot to like about the stock, even after the post earnings pop.

Investment Thesis

Peabody Energy is a large coal company that recently reported blowout Q4 earnings . The stock has lagged other major coal stocks in recent months, as least in part due to their inability to buy back stock or pay dividends due to their reclamation surety agreement. They had $1.3B in cash at year end and repaid all the secured debt outstanding. They did $1.2B in cash flow for 2022, and I think cash flows will continue to be impressive. With a $3.8B market cap, and dividends and buybacks on the way, I think investors are in for a fantastic couple of years with Peabody Energy.

Blowout Earnings

Peabody has lagged other coal stocks due to their inability to provide investors with capital returns. I think that could be about to change after their most recent earnings report. While I could go on and on about why earnings were so impressive, I figured it would be simpler to let CFO Mark Spurbeck say it in his own words.

Thanks, Jim, and good morning, everyone. In the fourth quarter, we recorded net income attributable to common stockholders of $632 million or $3.92 per diluted share and adjusted EBITDA of $501 million. We reported record free cash flow of $580 million and had $1.3 billion of cash at December 31 after repaying all of the remaining senior secured debt.

For the full year, we had record net income attributable to common stockholders of $1.3 billion, a 260% increase over the prior year. Adjusted EBITDA more than doubled to $1.8 billion. Our strong financial performance allowed us to retire all $545 million of the remaining senior secured debt in the fourth quarter, completing the repayment of over $1.1 billion for the full year.

Further, we are actively addressing the reclamation surety agreement to arrive at a sensible straightforward path to prefund all final reclamation costs and eliminate the remaining restriction on shareholder returns. We are optimistic this will be completed in the near future.

- CFO Mark Spurbeck on the Earnings C all

After 2022, the company has a cash rich balance sheet, lower debt, and is actively working on addressing reclamation costs so management can start rewarding shareholders with long awaited capital returns. Despite the massive 13% pop on Tuesday after the impressive earnings, I still think Peabody is dirt cheap.

Valuation

Before we get into the valuation too far, I think it's worth taking a look at the company's balance sheet first. The company has $1.3B in cash on the balance sheet even after repaying all of the senior secured debt. The company's current market cap is $3.8B, so they have over one third of their current market cap in cash. When we look at the cash flows the company produced in 2022, the stock looks mispriced to me.

They did $1.2B in operating cash flow in 2022, earning over $8 per share for the year. I think we could see similar cash flows in 2023, which means the shares are still attractive even after a massive run in the last couple years. For those looking for more information on Peabody, I would recommend going on Twitter and searching . There are a ton of informative tweets and threads on the company that could help investors understand the company and just how cheap it is. With shares near $30 today (it's Tuesday evening as I write this), I think the risk/reward is skewed to the upside, and I wouldn't be surprised to see Peabody trading at significantly higher levels in a year or two. One of the catalysts that is on the horizon is a potentially massive capital return program.

Capital Returns

This section is where there is some uncertainty. I don't think there is any uncertainty that patient investors will be rewarded with dividends and/or buybacks, but I'm curious to see what the capital return program will look like when it is announced.

As we mentioned at Investor Day, any shareholder return program that we're looking at is certainly going to be proportional to free cash flow and it's going to be flexible to return cash to shareholders through both buybacks and dividends.

- CFO Mark Spurbeck on the Earnings Call

I have seen some posts on Twitter saying that expect it to be similar to Arch Resources ( ARCH ), which has been buying back stock and paying out large variable dividends on top of a fixed payment. I don't want to get ahead of myself, but I do expect a large capital return program with a near even mix of dividends and buybacks if I had to guess. Whatever it looks like, I expect that the announcement of capital returns will be a catalyst for shares at some point in the near future.

Conclusion

Peabody Energy might not be for everybody, but for investors open to the idea of investing in a coal company, the risk/reward is very skewed to the upside today. I sold another put on Peabody last week, which looks like it will expire worthless in the next month if the market's reaction to earnings is any indication. It looks like I should have been buying calls instead, but hindsight is 20/20. It looks like it's only a matter of time before the reclamation surety liability is dealt with, and it looks like smooth sailing to me after that.

Peabody isn't a perfect company, and the coal sector has its issues, but I don't think coal is going anywhere. At the end of the day, an investment in Peabody comes down to simple math. They have one third of their market cap in cash, cash flows will probably continue to be huge, and they will start buying back stock and paying out dividends in the near future. That really only leaves one direction for the stock over the next year or two, which is up. While some investors might not want to chase shares after this week's move, I think Peabody still has significant upside, even after the large pop on the blowout earnings report.

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