BTU - Peabody Energy: Adding Again And Waiting For Capital Returns

2023-03-20 09:00:00 ET

Summary

• Peabody has sold off more than 20% since my last article due to volatile markets in the wake of the Silicon Valley Bank collapse.
• The company has a massive cash balance, some of which will go into capital returns after dealing with the reclamation surety agreement.
• I'm hoping for more buybacks than dividends, but I think we will see plenty of both.
• I have been looking at adding some call options and I discuss one chain that I will be watching, especially if shares drop further in the next couple weeks.

While the last couple weeks have been a rollercoaster in the market, I still think there are several compelling opportunities out there, especially in the energy sector. One that looks particularly timely is Peabody Energy ( BTU ). It’s only been a month since my last article on Peabody, but shares are down 20% after a significant drop in the last couple weeks. I have been adding lately and I think investors won’t regret adding shares to their portfolio at current prices.

Investment Thesis

The coal sector is cheap across the board, but Peabody is uniquely cheap in my opinion due to their inability to return capital to investors over the last couple years. With peers providing massive capital returns, Peabody hasn’t been able to buy back shares or pay dividends due to their reclamation surety agreement. I have heard rumblings on Twitter that capital returns will be coming sooner rather than later, and when the company does announce buybacks and/or dividends, I expect it to be a major catalyst for shares. I recently sold another put but I have also started to look at potentially buying a couple calls to add some juice on the upside. The recent drop in shares is just a case of short-term volatility and is a great chance to buy Peabody at a great price.

Dividends, Buybacks, Or A Mix?

I enjoyed reading Bram de Haas' article on Peabody that was published on Friday. I think we will see a mix of dividends and buybacks, but the shape of the capital return program is the subject of plenty of speculation on Twitter. Some want massive dividends over buybacks, while others push for buybacks due the dirt-cheap valuation.

I think the company could easily do a $6 per share special dividend or a $1 billion buyback program. It will likely institute a sustainable, dynamic dividend (percentage of free cash flow) and do a $300 million buyback program. Whether it will also do a special dividend is speculative, but it will have the capacity to do so in my opinion.

- Bram de Haas

The biggest catalyst on the horizon for Peabody investors right now is obviously the capital returns that are coming. I think the idea of a special dividend would be interesting, but I would much prefer a massive buyback, especially as long as shares are below $30. I try not to speculate on how big a capital return program will be before it is announced, but the company could easily return over a billion dollars to investors over the next couple years. While the market has been puking most risk assets after the recent Silicon Valley Bank blowup, this will allow Peabody to start a potential buyback program at even better prices.

Valuation

I’m not going to hammer on the cheap valuation too much since I talked about it extensively in my last article . What I will say is that the valuation is even more attractive due to the 20% drop in shares. They have a massive pile of cash on the balance sheet and while coal prices have come down, I still expect results for 2023 to be impressive. I thought shares of Peabody were a strong buy near $30 after earnings, and they look like an even better buy today.

Selling Another Put & Looking At Calls

I recently sold another put option on Peabody for 5$, with a strike price of $30. The contract expires April 6 ^th , so I’m underwater for now, but I am not worried about buying shares at $25. I have also started to look at buying calls again, which didn’t work out well the first time, but I think I will look at maturities that are farther out. I did some digging, and the following chain is one that I will be keeping an eye on.

Investors can look at going out further as far as maturity which I think could reduce your risk, but I think the 10/20/2023 expiration gives plenty of time for management to figure out capital returns and enough time for the market to wake up on the risk/reward for Peabody. These can swing wildly depending on what happens with shares, but the last trade on Friday was just over $2 per contract for the strike price of $30. If shares dip and send these contracts below $2, I might take a flier to add to my position in the shares.

Conclusion

While I didn’t have a massive bank failure on my bingo card for 2023, it’s not surprising that it would cause a selloff across markets. A company like Peabody Energy is about as far away as anything related to tech, venture capital, or financial contagion as any stock I can think of. They have real assets and cashflow, over $1.3B of cash on the balance sheet at year end (likely more by now), and a market cap of $3.4B. I think we are close to a huge capital return program, and the fact that shares are down over 20% in a month is just short-term volatility and a chance for investors to buy at even better prices. I have been looking at adding call options as a way to add to my position, but I think being long Peabody Energy over the next couple years is a no brainer.

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