BTU - Peabody Energy: Considering Coal Market Outlook The Stock Is A Hold

2023-05-23 04:34:12 ET

Summary

• Peabody Energy is a leading producer of both metallurgical and thermal coal. The company operates seventeen active coal mining operations across the United States and Australia.
• The share of coal consumption as an energy generator will not increase in OECD countries over the next three decades.
• However, it will maintain its significant proportion and even increase slightly in non-OECD manufacturing markets.
• Peabody Energy's financial results indicate that the company has strengthened its balance sheet and is now in a position to provide value to shareholders through dividends and share repurchases.

Introduction

Peabody Energy ( BTU ) is a leading producer of both metallurgical and thermal coal. The company operates seventeen active coal mining operations across the United States and Australia, while also brokering coal from other producers. In 2022, BTU acquired mining land in the U.S. for utility-scale photovoltaic solar generation and battery storage. BTU primarily contracts long-term supply agreements with electricity generators, industrial facilities, and steel manufacturers. However, in recent years, Peabody's customers have shifted towards shorter duration supply agreements due to fluctuating natural gas prices and increased use of renewable energy sources. In 2022, BTU's Seaborn Thermal Mining and Metallurgical Mining segments accounted for approximately 59% of the company's total revenue . The remaining 41% of revenue was generated by Peabody's Powder River Mining and other U.S. Thermal Mining segments.

Coal market outlook

Peabody's main focus is on producing thermal coal for electricity generation. However, recent trends in the energy sector suggest that the share of coal in electricity generation will decrease from 20% in 2022 to 17% in 2023 and 16% in 2024 in the United States. This is due to the increasing use of renewable energy sources like wind and solar, which have lower operating costs. Also, natural gas will see a slight increase in its share of electricity generation, rising to an average of 40% before dropping back down to 38% by 2024 due to higher natural gas prices and increased renewable energy capacity. Residential electricity demand is also expected to decline due to milder winter temperatures in 2023, with a forecasted reduction of 7% in heating degree days compared to 2022. Overall, U.S. coal production is expected to decline from 597 million short tons in 2022 to 577 and 491 million short tons in 2023 and 2024, respectively. This represents a decline of around 3% and 15%, primarily due to the retirement of coal-fired power plants, low natural gas prices, and increased renewable energy generation.

Figure 1 - U.S. electricity generation by source

What will be the long-term trends in energy consumption and generation sources? Over the next 30 years , non-OECD countries, particularly in Asia, are expected to experience significant economic growth and population increases. This will lead to a 50% increase in global energy use by 2050 compared to 2020, driven largely by increased demand for industrial manufacturing. In addition, residential electricity use in non-OECD countries is projected to more than double that of OECD countries by 2050. The industrial sector in non-OECD countries is also expected to consume more than double the energy of OECD countries by 2050 across all energy types. Figure 2 shows that while the share of coal consumption as an energy generator will not increase in OECD countries over the next three decades, it will maintain its significant proportion and even increase slightly in non-OECD manufacturing markets. This suggests that coal companies will continue to play a role in global energy production for years to come.

Figure 2 - Industrial energy consumption by source in OECD vs. non-OECD countries

Peabody financial results

In Q1 2023 , Peabody Energy's financial results indicate that the company has strengthened its balance sheet and is now in a position to provide value to shareholders through dividends and share repurchases. The company declared a quarterly dividend of $0.075 per share and authorized a $1 billion share repurchase program. Furthermore, their Adjusted EBITDA increased by 19% YoY to $390.6 million compared to $327.5 million in Q1 2022. Despite generating lower cash flow of $892 million in Q1 2023 compared to $1.3 billion at the end of 2022, the company's cash balance was higher YoY at $823 million in Q1 2022. Additionally, Peabody has significantly reduced its debt levels over the past few quarters, which now stands at $343 million in Q1 2023. This reduction in debt levels and negative net debt position has allowed the company to initiate its plan for shareholder returns. Finally, with an equity amount of $3.5 billion in Q1 2023, Peabody Energy is well-positioned to obtain both debt and equity financing without facing any significant challenges (see Figure 3).

Figure 3 - BTU's capital structure (in millions)

Based on the 144,700,000 outstanding common shares of the company at the end of Q1 2023, a dividend payment of $0.075 would cost $10,852,500. Fortunately, the company's free cash flow of $331 million at the end of Q1 2023 is more than enough to cover this cost. Moreover, it is encouraging that management has set a framework to return 65% of annual available free cash flow to shareholders. In detail, the company generated $386 million in operating cash flow in Q1 2023, which was lower than the $553 million generated at the end of 2022. Additionally, management has removed all restrictions on shareholder returns through an agreement with providers of a $1.3 billion surety program to establish a collateral limit. As a result, the company plans to enhance its shareholder return plan in H2 2023 (see Figure 4).

Figure 4 - BTU's free cash flow (in millions)

Peabody is expecting to boost its Seaborn Thermal volumes in the second quarter of 2023, with a target of 4.0 million tons, out of which 2.6 million tons will be exported. This represents an increase in production compared to the first quarter. During Q1, the seaborn thermal segment shipped 3.6 million tons, with exports accounting for 2.1 million tons. However, export shipments were lower than expected due to a longwall move at Wambo, which is completed now, and recovery from heavy rains towards the end of 2022. Other segments are also expected to see an increase in shipping volumes during Q2 compared to Q1 of 2023.

Conclusion

In this article, I have analyzed Peabody Energy's coal production segments. The company's primary production is focused on thermal coal, which is primarily used for electricity generation. Despite the company's strong cash and capital structures, there is a growing concern that the share of coal consumption in electricity generation will decrease in the United States in the coming years. However, looking at the long-term picture, it is expected that the proportion of coal use in non-OECD countries' industrial sectors will increase slowly by 2050, particularly in Asia due to higher GDP rates and population growth. Therefore, it is unlikely that global coal consumption will be eliminated from the picture anytime soon. Overall, considering coal consumption in the near future and long-term make me to keep my holding position.

For further details see: