Wednesday, August 24, 2022

Peabody Energy Corp. - Q2 2022 Results ($BTU)

We have written about Peabody Energy many times over the years - mostly as a short idea. In July 2015, their subordinated debt was trading for around 10 cents on the dollar. For the third quarter of 2015, Peabody lost $350 million, had $9 billion of net debt, and a de minimis market capitalization.

The situation is quite a bit different now. For the second quarter of 2022, Peabody earned $410 million on $1.3 billion of revenue and had free cash flow of $420 million. Net liabilities are now only $700 million and the market capitalization is $4 billion, for an enterprise value of $4.7 billion. So we are talking 2.5x annualized earnings and a 36% annualized FCF/EV yield.

As of the end of 2021, Peabody had 2.1 billion tons of proven coal reserves and 374 million tons probable. The proved reserves were comprised of 100 million tons seaborne thermal, 100 million seaborne met coal, 1.8 billion in the powder river basin, and 150 million tons of other U.S. thermal coal. One calculation that you could make is that the enterprise value is under $2 per ton of proved and probable reserves.

So far this year, seaborne thermal has been selling for $78 per ton with a $43 cost per ton; seaborne met coal for $300 per ton with a $131 cost per ton; PRB coal for $12 per ton with a $12 cost per ton (i.e. breakeven); and other U.S. thermal coal for $50 per ton with a $37 cost per ton.

Seaborne met coal has been the most profitable segment, earning $481 million the first half of this year. Seaborne thermal has earned $267 million. The PRB earned only $6 million, and other U.S. thermal has earned $112 million. 

As we've noted in the past, Powder River basin coal trades at a huge discount because it has a lower heat content than Appalachian coal and it is further from customers. The best Appalachian coal sells for 10x more per ton than PRB coal. Peabody's largest segment (by coal tons in reserve) is operating at breakeven profitability.

Something that has been troubling me about names like Peabody and U.S. Steel is that, while they are making tons of money right now, they do not have a history of consistent profitability. Peabody obviously went bankrupt, and U.S. Steel lurches from boom to bust.

These cheap cyclicals are printing money, but we can't help but wonder whether they are too junky, and a distraction from what we really want to own. Recall what Dantes says in the Count of Monte Cristo:

"I make three assortments in fortunes — first-rate, second-rate, and third-rate fortunes. I call those first-rate which are composed of treasures one possesses under one’s hand, such as mines, lands, and funded property, in such states as France, Austria, and England, provided these treasures and property form a total of about a hundred millions; I call those second-rate fortunes, gained by manufacturing enterprises, joint-stock companies, viceroyalties, and principalities, not drawing more than 1,500,000 francs, the whole forming a capital of about fifty millions; finally, I call those third-rate fortunes, composed of a fluctuating capital, dependent upon the will of others, or upon chances which a bankruptcy involves or a false telegraph shakes, such as banks, speculations of the day—in fact, all operations under the influence of greater or less mischances, the whole bringing in a real or fictitious capital of about fifteen millions."

We are really interested in finding royalties and tollbooth businesses that we can hold through a significant coming inflation. An operation under the influence of greater or less mischances is something that we may be forced to sell because of poor capital allocation by or other disagreements with management. That would expose us to loss or to paying taxes on partly illusory (nominal) capital gains.

We should do better over time with investments that have lower volatility of operating profits and the highest percentage of revenue returned to shareholders, provided that we buy them at attractive prices. Remember our discussion of hydrocarbon royalties and pipelines? Profits that fluctuate into the red are signs of weak business models and poor competitive position.

Royalty trusts never lose money, by definition. Pipelines basically never lose money. The cigarette companies may have to take a non-cash writeoff of a stupid acquisition, but their operations are always profitable.

Public sector employees (university professors with tenure, as an example) do very well for themselves, when you consider that they are paid public sector wages and are selected for a lack of interest in wealth creation. This may be because of the lack of volatility in their earnings - they are never unemployed. 

This is a theme worth exploring further - slow, boring consistency as a path to long-term survival.

1 comment:

Allan Folz said...

It would be an interesting and instructive blog post to go through companies and sectors and judge them to be first, second, third rate with slightly updated standards for contemporary times.

First rate are easy enough to identify. And you've written a fair amount on them already... tobacco and energy royalties. Midstream could be first rate, but debt levels (and often empire-building managements) make them not entirely masters of their own destiny.

Second rate are industrials with a moat, almost always regulatory. One just needs to watch the water level in the moat.

I think near-royalties like oil sands fall here and not in the first-rate category because if the western world had its act together oil could easily be 50% cheaper. Ironically, it also makes refineries and fertilizer companies second rate instead of third rate, if they aren't under-capitalized. We can't build new refineries in the West and for last 10 years have only mothballed them. (Note, they are bringing new refineries online in the Middle East and China, so in another 5 years refineries will probably go back to being third rate. Again, watch the moat.)

Third rate are industrials without a moat. Good for a trade, but never a hodl.

In retrospect, my sh*tco refiner failed the under-capitalized test and is proving to be a third rate investment. Peabody is third-rate because they fail the capitalization test, being forced to sell their biggest reserve for cost.

Tankers, of course, have no moat, but they are long-lead time to build, so good for a trade. You could maybe argue the IMO reg's and long-lead times make them 2nd rate for the time-being, until 2030 or so, but you'd be wrong. With their history they don't get a benefit of the doubt. Also, if one has to constantly watch the order book, it's not a second rate investment.

Steel producers have no moat because too many sh*thole gov's will dump product on the world market for their own political expediency, especially the biggest sh*thole of them all: China.

Finally, EV's have no moat. Of course. Battery tech is not their own and there's nothing proprietary about an electric motor. Again, you've spilled a lot of ink on EV's already, but it's always good to remind people every chance one gets.