BTU - Peabody Energy: A Cheap Diversified Coal Mining Company

2024-01-15 23:27:59 ET

Summary

• Peabody Energy is the largest coal mining company in the US, with significant production in Eastern Australia.
• BTU has 4 different business segments, with the majority of production in the Powder River Basin.
• The Seaborne Thermal and Seaborne Metallurgical segments have been the main contributors to adjusted EBITDA, with a focus on expanding the Seaborne Metallurgical segment in the future.

Overview

Peabody Energy Corporation ( BTU ) is the largest coal mining company in the United States, with 125M short tons of coal sales over the last twelve months. The company has a substantial amount of production in Queensland & New South Wales, Australia, apart from its production in the U.S.

Peabody is a diversified coal mining company with 4 different business segments: Seaborne Thermal, Seaborne Metallurgical, Powder River Basin, and Other U.S. Thermal.

Most of its production is in the Powder River Basin, but due to a much lower sales price and margin compared to the other segments, it has lately had a relatively small contribution to total adjusted EBITDA. Much of the adjusted EBITDA has recently come from the two seaborne segments. The company is also investing to grow the Seaborne Metallurgical segment, so the contribution from that segment is expected to increase further over time.

The performance of Peabody has been -11% in the last year, with dividends included, where the decline in thermal coal prices has naturally had an effect, the relatively strong coking coal prices have likely offset part of the decline on the thermal side. The performance has been similar to many oil & natural gas producers lately, flat or slightly negative.

Quality Characteristics

Peabody has historically had a decent amount of debt, but it has used the strong cash flows over the last few years to deleverage. The company nowadays has virtually no financial leverage, with a substantial cash position, and a deeply negative net debt position. There is also a large, restricted cash position to cover some long-term liabilities.

The company is committed to returning 65% of the free cash flow to shareholders. There is a small regular dividend of $0.075 per share and quarter, which equates to a dividend yield of 1.3%, but most of the capital has in 2023 been allocated to shareholders via buybacks.

In 2023, up until October 20th, $286.7M in buybacks repurchased 13.4M shares or 9.3% of shares outstanding, which is an impressive figure.

Valuation

Peabody did on the 27th of October 2023 have 131.1M basic shares outstanding, I have added 16.1M to the share count to account for the dilutive effect from the convertibles, but I also removed $320M from debt side to avoid double counting the convertibles. With the latest share price of $23.80, Peabody has a diluted market cap of $3.5B and an enterprise value of $2.5B.

Given the many different segments, it is difficult to precisely estimate the free cash flow in 2024 and beyond. The brokers on Koyfin are estimating the 2023 free cash flow to $827M, which is in line with what we have seen in the first three quarters of the year. The 2024 estimate is substantially lower at $531M, which I don't think is overly aggressive at least.

So, with the broker estimates, Koyfin looks to be trading with a free cash flow yield of 21% for 2024. Even if we were to lower the FCF estimate to $400M, we are still talking about an FCF yield of 16%. That is a very attractive valuation for a company that is aggressively buying back its shares.

Concerns & Conclusion

Peabody Energy has large reserves in the Powder River Basin, with an average mine life of around 20 years there. The mine lives are substantially shorter for the operating mines in other more profitable business segments. It is not a near-term concern, but still something that likely needs to be addressed with some more capital investments over the next 3-5 years. I do expect many of the mine lives to be extended over time.

The main concern with Peabody is in my view the exposure to Australia, where the local governments in Queensland and New South Wales have both recently raised the royalties. The announced increase for 2024 in New South Wales is more marginal, which is an increase of 2.6% to around 10% depending on the type of mine.

The Queensland royalty hike that was implemented in 2022 was more confiscatory in nature, where the rate now goes as high as 40% for prices above A$300/t.

The majority of Peabody's production is in the United States, but much of the higher margin sales come from Australia, and the majority of the Seaborne Metallurgical production is in Queensland.

With that said, it is worth keeping in mind that the 2023 figures have already been impacted by the new Queensland royalties and the New South Wales royalties will have more of a marginal impact. Peabody looks to generate over $800M in free cash flow during 2023. So, it is probably fair to say that the higher royalties are already reflected in the current share price.

I consider Peabody a good buy here for anyone who is looking to increase their overall exposure to coal. Peabody is today primarily a thermal coal producer, where the EBITDA contribution from metallurgical sales is somewhere in the 25-40% range depending on coal prices. The metallurgical exposure is expected to grow over time though.

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