BTU - Peabody Energy Corporation: 2022 Boom Could Usher 2023 Dip

Summary

• BTU has been on an upward trajectory over the last year, gaining almost 130% in share prices.
• The excellent results were possible due to high coal prices and strong demand for the product.
• Early this year, coal prices have declined, and in some cases, like the US, they have plummeted by more than 40% putting the short-run success to the test.
• Long-term coal price projections predict prices will continue to fall, indicating that the company's future expansion will be constrained.

Investment Thesis

Coal firms have done well over the past year due to the increasing demand for the product and the high prices. Peabody Energy Corporation ( BTU ) shares have increased by nearly 130% during the same time frame. The company's balance sheet has been strengthening, and it has also been generating positive cash flows. The high demand for coal, which further pushed prices high, was caused by the mayhem in the energy sector caused by the war between Russia and Ukraine; we saw significant supply shortages in the oil and gas industry.

This supply bottleneck forced the energy sector to pursue ways to fill the gap, including coal and other renewable energy sources. Despite the company's rapid expansion due to rising pricing and robust demand, it appears that 2023 will severely blow the company's development. Several projections indicate that coal prices will decline throughout the year and the foreseeable future. Coal prices in the United States have dropped by more than 40 percent recently, which, in my opinion, will hurt the company.

Coal Prices Plummet In Early 2023

Warm winter temperatures in the United States reduced demand for coal, resulting in a decline in prices. For the week ending January 6, the price of Northern Appalachian coal fell to $115 per ton, a decrease of 45 percent from the previous week. The spot price of coal in Central Appalachia decreased by 33%.

The war between Russia and Ukraine has thrown international markets into chaos, leading to a sharp increase in prices worldwide during the past year. Warmer temperatures, especially in Europe, have reduced worries about fuel shortages and contributed to lower demand and prices. Throughout the world, coal is losing ground. There has been a 6.6% drop in Australia's benchmark pricing and a 4.2% drop in Europe's benchmark since the beginning of the year.

By the end of 2022, the term of some very expensive contracts had run out. Customers are putting orders for shipments that won't begin until the second quarter, so they'll need to look months ahead to gauge the market. Yet, the general consensus is that coal prices will be lower, though bids may climb again in the coming weeks as the picture becomes clearer.

Coal price forecast

After the sudden drop in coal prices at the beginning of the year, I'll be interested in the long-term projections because I think the company's balance sheet is strong enough to withstand any short-term price fluctuations. Below are some predictions regarding coal prices :

• Fitch Solutions predicted that by 2023, the price of coal for use in power plants would have dropped to $280 per tonne from an anticipated $320 per tonne in 2022.
• Bank of America Global Research projected on September 5 that the average price of coal will fall from an estimated $334.1 in 2022 to $300 per tonne in 2023 and $260 per tonne in 2024. BofA predicted that the price of thermal coal would fall to $190 in 2025 and $140 in 2026. Beyond 2026, the bank forecasts a long-term average price of $83.20/tonne for coal.
• On the other hand, ANZ Research and Trading Economics projected a higher coal price. It forecasts that the average price of Newcastle coal will rise from $344 in 2022 to $361 in March 2023 before falling to $279 in 2024.
• World bank projected that coal prices would decline in 2023 from their record high in 2022 .

In my view, the forecast above is based on the assumption that there will be massive investment in coal due to its high prices hence normalizing prices. China, India, and Indonesia, the world's three largest coal producers, will all set output records this year. However, despite high prices and comfortable margins for coal producers, there is little indication of a surge in investment in export-driven coal projects.

I expect the increased output from the three big producers to go a long way toward balancing coal prices, although there is little evidence of substantial investment in coal. Coal prices may also be affected by the growing popularity of alternatives to fossil fuels like solar, wind, and hydropower.

Strong Balance Sheet: A buffer In The Short Term

BTU has what I would consider an excellent balance sheet. To begin with, it has a very low debt of $882.50M which is 0.22X its market cap of $3.99B. This low debt ratio demonstrates the company's minimal level of leverage, mainly when high-interest rates make debt financing extremely risky. Concerning liquidity, BTU has a current ratio of 1.79X and a cash balance of $1.35B, which is greater than the total revenue for Q3 2022 ($1.34B), the highest quarterly revenue since 2020. This demonstrates that the company's current cash position is sufficient to fund operations for another quarter, which would be the most successful one in terms of revenues since 2020. This demonstrates how safe the business is in the short term, despite prices dropping.

Conclusion

Increasing demand and steep coal prices propelled BTU prices upward in 2022. However, early this year, coal prices dropped by more than 40% in some cases, such as the US, putting a strain on the company's short-term success. But the company's excellent financial position protects it from short-term uncertainty.

With the short-term dwindled by price declines but buffered by a strong balance sheet, the long-term price decline projection matters to me. With most projections estimating price declines in coal prices from 2023 and beyond, this company's long-term success is compromised and doesn't look promising. Having reported a significant share price gain over the last year, I anticipate its share prices to decline as coal prices go down. In other words, it's unlikely the company's shares will have any significant share growth both in the short and long run, but in my view, a strong downside potential lies ahead. Given this background, it's high time to cash out the profits realized over the last year and wait for the stock to dip. I recommend a hold rating for potential investors to see how the company responds to this price volatility.

For further details see: