Morning Earnings: Peabody Energy ($BTU)

Peabody Energy (BTU, previously) reported results. Highlights:

• In the fourth quarter, the company generated $438.4 million of operating cash flow and used $11.8 million of investing cash flow (net of cash receipts from Middlemount and other related parties of $36.3 million), resulting in Free Cash Flow of $426.6 million.
  
• During the quarter, the company continued to make progress on its debt reduction activities. The company retired $154.4 million of senior secured debt through open market repurchases. The company also completed multiple debt-for-equity exchanges and issued 3.3 million shares of common stock in exchange for $45.4 million of senior secured notes. 
• ...approximately $420 million of debt retirements year to date, more than 26% of debt outstanding at the start of the year.
  
• During the fourth quarter, the company sold an additional 7.7 million shares of common stock under its previously announced "at-the-market" equity offering program (ATM), raising net cash proceeds of $92.6 million and resulting in 7.7 million shares remaining available under the ATM program.
• Cost per ton are anticipated to increase compared to the prior year as a result of higher royalties and fuel prices, in addition to incremental costs to increase near term production.

Our first post ever about old Peabody (pre-bankruptcy) in 2015 when it had subordinated debt trading at a yield to maturity of 40%. How things have changed. Now Peabody is free cash flow positive, deleveraging, and has debt trading close to par.

Peabody's current market cap is $1.9 billion, and I count $2.2 billion of net debt, for a total enterprise value of $4.2 billion. The FCF/EV yield is 41%. I think we could call that a cheap cyclical! 

With Peabody's $420 million of cash from operations in 2021, they spent $165 million in capital expenditures, a reinvestment ratio of 39%. In Q4, they reinvested only 10% (net) of their operating cash flow in capex. This is the same pattern we saw at the integrated oil majors, which are investing less than half of their operating cash flows in maintaining production. 

It is amazing watching these natural resource management teams - Canadian oil majors are a great example - so scarred by the recent bear market that they want to run basically deleveraged companies. They're using free cash flow to pay off debt with negative real yields!

"Arch Coal Lenders Balk at Bond Deal"

"Arch Coal Inc. is under mounting pressure to get a grip on its dwindling cash. The miner is saddled with $5.1 billion of debt and has failed to clinch a deal with creditors to swap existing bonds for new securities with longer maturities, which would help the company cut its obligations and ride out a commodities slump. Now Arch is three weeks away from an $18.1 million interest payment on some of the bonds it wants to make disappear. With the company’s senior lenders not wanting to see that cash used up, they’re likely to pressure the company to skip the payment..."

Apparently, unsecured creditors have agreed to a deal with the company to swap their notes for a lower face amount of secured debt, BUT the existing secured lenders are refusing to consent because more debt pari passu with them would lower their recoveries.

The senior lenders want that deal blocked, and they want the company to stop making payments on unsecured debt.

Thermal Coal Prices Keep Falling

• Powder River Basin (PRB) Coal price chart
• Central Appalachian Coal price chart

WSJ: "Hedge Funds Bet on Coal-Mining Failures" $WLT

Funds are trading the capital structure by shorting the unsecured debt! (link)

Walter Energy is a particular favorite of distressed-debt investors, including Apollo Global Management LLC, Brigade Capital Management LP, Caspian Capital Management and Knighthead Capital Management LLC...

Walter owns some low-cost mines that produce metallurgical coal, the type used to make steel and the hardest hit in the recent downturn. Those mines could be profitable immediately if they aren’t saddled with Walter’s debt, analysts said.

The funds have been buying up much of a $1 billion bond secured by Walter’s assets for 85 to 90 cents on the dollar, people familiar with the matter said. The holders would have first claim to Walter’s assets in a bankruptcy. Meanwhile, the bonds yield as much as 14% at current prices.

Several of the funds had also sold short the company’s unsecured bonds, a wager that their value will fall. The bonds have lost 58% since June 30 and trade for 27 cents on the dollar.

"Miners Shovel Coal Into Flooded Market" $WLT

Miners are shoveling more metallurgical coal on to a global market already awash with the steelmaking commodity, delaying any recovery in prices that are at multiyear lows.[...]

BHP Billiton Ltd. became the latest company to unveil record output of metallurgical coal, after opening new mines planned years ago when prices of the commodity were at a peak. But the extra supply is far outpacing demand in countries such as China and Japan, which produce much of the world's steel. Miners' willingness to dig up more coal despite lower prices mirrors a similar push in iron-ore where miners are investing billions of dollars and running their operations harder in a bet that their enormous efficiencies of scale will allow them to profit. However, critics say the strategy risks creating a supply glut of each of the raw materials used to make steel that will take years to clear.[...]

The supply surge is weighing on prices, and forcing analysts to redraw their expectations of a recovery. Many companies with unprofitable mines are opting to wait out the downturn, rather than shuttering production and laying off staff. [...]

"We are forecasting a surplus again in coking coal in 2015," said Christopher LaFemina, an analyst at broker Jefferies who estimates the market oversupply will double to 20 million tons in 2015 from 10 million tons in 2014. Consequently, the potential for coal prices to rise "is likely to be much more limited than we had previously anticipated," he said.

Isn't the potential for coal prices to rise not just unlikely, but in fact more likely for prices to fall, if the size of the met coal surplus is going to increase next year?

The implications for high cost miners are so grim that many in the industry seem to prefer to hide their heads in the sand about what's coming.

"China Tariff On Imports Could Dramatically Impact Already Hard-Hit Coal Producers" $WLT

Forbes:

The decision by China – the world’s top coal importer – to put a 3% tariff on anthracite and coking coal and 6% tariff on thermal coal reverses a near decade-long policy to remove barriers to imports, making a near-term rebound in coal prices increasingly less likely, analysts say.

“The timing of a met coal price rebound is becoming increasingly important for liquidity-constrained met coal producers Walter Energy, Alpha Natural Resources, Arch Coal,” said Morgan Stanley

Murray Comments on Coal Industry

Murray also scoffed at claims from some coal companies that they are reducing costs to compete during the downturn. Murray did not name any specific coal producers.

"These coal companies are telling you, 'Well, we're reducing our costs to compete in this bad market.' Hey, bankruptcy coming!" he said. "Because in the coal business, you already had your costs as low as you could possibly make them every day. That is garbage from public coal companies who are worried about their stock price. Be alerted."

"Goldman Proclaims the End of the Iron Age"

Source:

"The iron ore price has just hit a new 5-year low and Goldman is out with a piece in which they conclude that the 'end of the iron age' is near. Goldman basically states that we are shifting from an under supply phase in iron ore (2004-2014) to an oversupply phase which can be expected to last at least a decade. This comes as a result of the huge lags between investment and production – classic 'Schweinezyklus.'"

Quoting the GS piece, this amazing tidbit:

"On a per capita basis, the average household in China is accumulating steel at a rate equivalent to the purchase of a new car every 8 months (without disposing of its older cars)."

The Vienna Capitalist has an interesting theory about the damage that the Chinese "stimulus" did in terms of malinvestment.

"iron ore mining investment has really taken-off after the financial crisis, i.e. after we have already had books touting the commodity (around August 2008 oil hit USD 150/barrel) supercycle for half a decade. I can only speculate about why this is the case – long lead time for mine investments play a role for sure – but I think it also has to do with the fact that China’s investment binge really got out of control as a result of their huge stimulus program during the financial crisis."

Everyone thinks that we're at a "permanently high plateau" but the next crash is going to be big.

"Jeffries on coal M&A"

A correspondent sent in,

"Jefferies LLC, however, in a note released March 25, said it has long been skeptical of mining acquisitions because merging two mining companies typically offers 'very little' in the way of synergies. Jefferies was particularly critical of Alpha Natural Resources Inc.'s acquisition of Massey Energy Co.

'In our opinion, the problem for U.S. coal did not start with the weak natural gas prices of 2012. Rather, we'd argue the problems started with a wave of M&A during the previous year,' Jefferies analyst Peter Ward said. 'In two decades covering the mining industry, these were some of the most regrettable transactions we had ever seen. And, we said so at the time. Sadly, we have seen too much of a desire to get bigger simply for the sake of getting bigger throughout the mining industry.'"

Platts: "Lower offers, more supply hit second-tier metallurgical coal"

Yesterday:

"Spot prices of second-tier metallurgical coals in the Asia-Pacific region fell July 29 on lower offers and stronger availability."

More Color on Met Coal

Sent in by a correspondent,

"Met coal production growth is showing no signs of withering, with global met coal producers, including BHP Billiton Ltd., Teck Resources Ltd. and Rio Tinto, reporting strong production growth in the second quarter...

For the fiscal year ending 2015, BHP increased its met coal production guidance by 5%, to 47 million tonnes. Teck said that although its met coal production was up in the second quarter of 2014, its met coal platform was running below capacity.

Weakness in the global met coal market has been marked by declining prices that were hovering around seven-yearlows, at $120/tonne... Met coal is trading at about $112/tonne on the spot market."

Partial List of Met Coal Miners in U.S.

• Alpha Natural Resources - earnings August 6
• Arch Coal - Q2 report: "'Recently, we’ve announced the idling of our Cumberland River complex in response to weak global metallurgical coal prices,' said Eaves. 'Although idling higher-cost coking coal capacity lowers our metallurgical coal volume expectations for 2014, it also shifts our mine portfolio toward higher-margin metallurgical coal operations and enhances our competitive cost position in that region.'"
• Consol Energy - Q2 report
• Cliffs Natural Resources - Q2 report: "During the three months ended June 30, 2014, our North American Coal business segment market pricing has continued to be affected by various supply and demand pressures in the metallurgical coal markets, which has impacted negatively revenue by $65.3 million and decreased our realized revenue rate by 30.6 percent."
• James River Coal
• Patriot Coal
• Teck Resources - Q2 report: "Coal prices in U.S. dollar terms were lower by 29% in the second quarter of 2014 compared with a year ago and 15% lower than the first quarter of 2014."
• Walter Energy

"SNL Energy: James River Coal's recovery from bankruptcy could be hindered by contracts" $JRCC

Wow, no wonder they have to keep postponing the auction, indeed - SNL article:

"But James River also is burdened by a wealth of expiring utility contracts and a sharp decline in coal purchases in 2013 compared to 2012. The biggest blow was Southern Co.'s decision to all but cease coal purchases from Central Appalachia by 2016 and retire units at three older, coal-fired power plants in Georgia.

On a companywide basis, James River was the largest supplier of Central Appalachian coal to Southern plants in 2012, shipping 1.7 million tons to the company. Southern was James River's largest utility customer overall in 2012, and it purchased exclusively Central Appalachian coal from the company.

Based on U.S. Energy Information Administration fuel contract data, nearly 51% of the Central Appalachian coal and about 31% of the total coal delivered to electric utilities by James River in 2012 went to Southern-operated plants. The diminishing number of sales contracts also may limit interest in James River's assets."

CAPP coal can't compete with PRB coal, which is an order of magnitude more efficient per employee hour.

Glut of Coal Assets for Sale

Link:

"While Westmoreland Coal Co. is still in the middle of integrating its newly acquired Canadian coal mines purchased from Sherritt International Corp., executives said there is no shortage of companies looking to off-load other coal assets."

Is this why the James River Coal bankruptcy auction keeps being postponed? What results would Walter Energy have if they needed to sell a coal asset?

Moody's Comment on Met Coal Market and U.S. Miners' Cash Burn

Article mentioning Moody's comments:

BHP Billiton, the world’s largest miner, recently announced record metallurgical coal production of 45 million t for the year to June 2014 on the back of record Australian production. A further 30 million t of capacity is due to come online over the next three years in the country from projects that have already started or preparing to commence construction.

This growth will offset any capacity curtailments in Australia in the next twelve months and will lead to growing exports after that, said Moody’s. As a result of this continued downward pressure, Moody’s expects only a small increase in prices to US$135 – US$145/t by the end of 2015 with prices struggling to rise higher than that for three years after that.

At that level, Moody’s believes US miners will continue to struggle: “We believe that as a group, key US met producers [including Peabody, Alpha Natural Resources, Arch Coal and Walter Energy] will [burn] well over US$1 billion in cash in 2014.” Only when benchmark prices reach the US$160 – US$170/t range will the group become cash positive.

Couple Comments on Metallurgical Coal Credits

UBS on coal miners:

"In our view, Alpha, Arch, and Walter may not be good Chapter 11 restructuring candidates since debt comprises most of the long term liability pie. There may be limited ability to shed other liabilities through a restructuring process. Hence, it may make more sense for unsecured bondholders to do exchange offers or agree to other concessions out of bankruptcy. That said, companies with a larger amount of secured debt, like Walter, may be more inclined to go through a Chapter 11 process in anticipation of higher recoveries."

Moody's on met coal:

"At these prices, all Moody's-rated US met coal producers will continue to be stressed, with those that acquired met-coal assets at the height of the market labouring under very high leverage."

Sounds like WLT.

More Thoughts On Walter Energy

Walter Energy's cash may be seriously eroding with these metallurgical coal prices (mentioned by an Australian competitor), which are down significantly from the first quarter.

"Whitehaven’s metallurgical coal achieved an average price of $US93.63 a tonne in the June quarter, which it expects to fall to as low as $US91 a tonne in the current quarter."

By comparison, in Walter's Q1 2014 report, it disclosed that its

"average selling price of hard coking coal in the first quarter of 2014 was $127.39 per metric ton, representing a 19.0% decrease from the average selling price of $157.28 per metric ton for the same period in 2013."

So, we are talking about a sales price that has fallen significantly from Q1. Speaking of Australia, you have to understand what happened over the past four years in metallurgical coal to understand the problem Walter Energy is having:

"Australian met coal producers have an advantage over U.S. ones due to a freight and quality advantage, so U.S. met coal producers have a better shot at domestic use and at selling to European consumers. U.S. producers are marginal producers, particularly susceptible to decreases in demand because they have higher freight costs and lower quality coal.

Flooding in Australia in 2010-2011 caused a met coal supply shock, pushing up the prices of iron ore, steel, and especially met coal. At the same time that this supply shock abated, the frenzy of construction in China and therefore demand for steel has started to slow."

Unfortunately, in November 2010 - during this temporary supply shock that also occurred during a demand shock of China using an unsustainable amount of basic materials (i.e. "top of cycle") - Walter Energy decided to go out and pay $3.25 billion for Western Coal. From a December 2010 press release:

"This is a transformative transaction at a time when global demand for metallurgical coal is surging," said Joe Leonard, interim chief executive officer of Walter Energy. "Western Coal has an attractive high-quality metallurgical coal asset base and has embarked on an organic growth strategy that is expected to increase production more than 60 percent by fiscal 2013. It is a unique strategic fit with Walter Energy's large scale, high-productivity mines which produce premium-quality metallurgical coal for customers in South America and Europe. Our combined production capacity and geographic footprint leaves us extremely well positioned to benefit from favorable sector dynamics driven by increased steel production in markets such as China, India and Brazil. Bottom line, this is the right transaction at the right time."

Speaking of Australia, you never want to hear that your lower cost competitors are "holding up well" selling below your cash cost.

"Australian producers of metallurgical coal are holding up well at today’s 'extremely low' prices, and said only a few operators were incentivised to close mines"

A correspondent writes, "Yep, this is how markets for commodities clear. High cost producers have to shut down."

"Severstal selling North American coal assets for $140m"

Headline:

"Severstal is selling its North American coal assets, PBS Coals Inc, to Canada's Corsa Coal Corp for an enterprise value of $140 million. The Moscow-based steelmaker purchased the assets in 2008 for about $1 billion."

An 86 percent loss! A correspondent writes,

"This is an ugly benchmark. Enterprise value could be as little as $120 million, depending on how the environmental tail plays out. They produced 3.3mm tons of coal last year and half of it was thermal. No mention of reserves. Those JRCCQ bonds should be trading at a penny after this."

"High Yield" Coal Bonds

Coal has had some rough times because of competition from cheap natural gas the past few years. Some of the coal companies have had negative income and even operating profit for multiple years in a row.

You'd think maybe there's be some distressed debt opportunities, but the bonds are extremely expensive.

• Alpha Natural Resources - mines coal in VA, WV, KY (higher cost) in addition to WY. EBIT less than interest expense the past three years. Highest yielding bond 13%.
• Armstrong Energy - Illinois basin coal (better), but operating income hasn't covered interest expense  since 2009, yet bond only yields 8.7%.
• Peabody (BTU) - good coal but highest yielding bond less than 7%.
• CLD - Powder River Basin (good coal), but highest yielding bond only 5.6%. Is profitable and covering interest expense though.
• Consol - highest yielding debt 5.5%.
• Westmoreland - yielding about 5%

This is probably the type of debt that yield hunger funds have shorted the long bond to buy.

Coal Industry

“Right now the industry is under siege, so you just create liquidity now and worry about fixing your balance sheet later,” Evan Mann, a senior bond analyst at Gimme Credit LLC, said by telephone from New York. “It buys everybody more time for there to be a recovery.”