Peabody Energy Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Peabody Energy Corporation is the world’s largest private-sector coal producer, focusing on thermal and metallurgical coal for power generation and steel production, primarily operating mines in the U.S. and Australia.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Peabody Energy Corporation (BTU) operates in the global coal industry, which is cyclical and subject to volatile market conditions. As such, its business model is inherently tied to macroeconomic factors, supply-demand dynamics and regulatory policies, requiring a constant adjustment of its strategy to maintain profitability and deliver shareholder value. The company’s primary objective remains to be a low-cost producer.

Business Overview

  • Revenue Distribution: Peabody derives its revenues primarily from the sale of thermal and metallurgical coal. Thermal coal is used in power generation, while metallurgical coal is essential for steel production. Revenue streams are determined by a complex web of global coal supply agreements, which often involve price adjustment clauses and supply obligations. Sales are typically long-term contracts, with the majority of coal sales priced on a benchmark basis or according to the contract’s pricing terms, rather than spot pricing. In the first half of 2023, Seaborne Thermal coal comprised 38%, Seaborne Metallurgical comprised 41% and US Thermal made up 21% of revenues.
  • Industry Trends: The coal industry has witnessed a structural decline in usage for power generation as economies transition to cleaner energy sources, while metallurgical coal continues to be driven by the demand from the steel-producing industry, especially in developing nations like China, India and Southeast Asia. Factors like economic growth, energy demands, geopolitical situations, weather patterns, and regulatory conditions heavily influence supply, demand, and prices. For example, recent years have been dominated by supply chain issues that have inflated prices significantly as well as a very uncertain geopolitical environment.

The coal industry is extremely volatile and difficult to understand, which is a problem for new investors looking into the industry.

  • Competitive Landscape: The coal industry is characterized by intense global competition. Peabody operates alongside large, established players (such as Glencore, BHP and other international players), as well as a myriad of smaller firms. Competition is based on several key factors including pricing, operating costs and efficiency, product quality, geopolitical positioning and the ability to execute long term contracts reliably. While larger players often control a large market share and have substantial resources, they are not immune to the volatility of commodity prices and market conditions.

Peabody’s success is driven by managing the volatile commodities they sell, while maintaining a good cost structure.

  • What makes Peabody different: Peabody is one of the largest coal producers and is able to obtain long-term contracts with its customers and is able to use its massive infrastructure and scale in order to generate profits. Also, a substantial portion of its revenue is from seaborne metallurgical coal which is less impacted by the global move away from coal.

Financials

  • Latest Earnings: Peabody Energy’s most recent earnings report (Q3 2023) showed mixed results. Revenue decreased by 19.4% YoY to $1.17 billion due to a decline in volumes partially offset by higher prices. Operating costs increased due to higher royalties and expenses, which combined with lower revenue led to adjusted EBITDA of $290.1 million (a YoY decrease of 52.3%.)

Peabody recently saw a major drop in EBITDA, which was not fully offset by higher prices. This trend must be watched closely in the future.

  • Margins: Peabody’s margins are highly dependent on the price of coal, with the company using contracts that are usually based on indices. In 2022 and earlier parts of 2023, Peabody’s EBITDA margin was very high (around 30%) as they were experiencing high prices. However, for the last few quarters the prices and the margins have seen a decline.

High coal prices will result in high profitability for BTU, so future profitability is extremely tied to the price of coal which is determined by a lot of external factors.

  • Balance Sheet: Peabody has maintained a reasonable balance sheet health, however there are some concerning aspects of it that should be watched. As of September 30, 2023, the company had $1.44 billion of cash on hand, and $1.07 billion of net debt, a substantial amount of financial liabilities. The company also has around $2.94 billion in property, plant, and equipment and mine development, which is a good base of assets.

The company is maintaining a good balance sheet, but its heavy reliance on debt should be watched.

*   The company has a large amount of debt due to the recent recapitalization that happened in the second quarter. It should be noted that the company has no scheduled debt payments for the next few years, which should give it some breathing room in the near term.
*   There are also huge pension and postretirement obligations that are equal to 2.1 billion, which must be taken into account while doing a valuation.
  • Cash flows: Peabody’s ability to generate cash is directly linked to its profitability, which has been extremely volatile in the last couple of years. Cash generation was very strong during the first half of 2022, but it has decreased materially since. From an operational perspective, there is a lot of seasonality in Peabody’s business, which may further affect cash generation on a quarterly basis.

Moat Analysis

  • Moat Rating: 3/5
    • Rationale:
      • Barriers to Entry: The coal industry has significant barriers to entry because of the large capital expenditure needed to start a large mining operation, environmental permits required and transportation and infrastructure needs. These barriers make it difficult for new entrants to compete on an equal footing with existing players.
      • Cost Advantages: Peabody benefits from economies of scale and its access to low-cost coal reserves. Its large-scale operations, along with its access to low-cost deposits in Wyoming and Australia and technological integration give it a cost advantage over its competitors.
      • Geographic advantages: Peabody benefits by being close to the end customers for their thermal coal operations, as shipping coal over large distances is not efficient.
  • Limitations of Moat:
    • Commodity Nature: While Peabody enjoys some of the benefits described above, it is operating within a commodities industry, where price fluctuations are a big detriment to economic profits.
    • Technological Disruption: With global moves away from coal, Peabody’s moat might be disrupted and severely affected, as many governments are encouraging the use of cleaner energies.
    • Regulation: Political and regulatory uncertainty, particularly with respect to emissions and environmental standards, can be a huge impediment for Peabody.
    • Competition: Although Peabody is a major player, there is tough competition from international rivals, that can affect its business greatly.

Risks to the Moat and Business Resilience

  • Economic and Geopolitical Risks: Global economic downturns can significantly decrease the demand for energy, which in turn would negatively affect coal prices and thus Peabody’s revenue. Also, there are many geopolitical risks that can affect the prices of raw materials.
  • Regulatory Risks: Environmental regulations, such as taxes on carbon emissions and limitations on the use of coal, are a major threat that can hurt the business.
  • Market Shifts: The increasing adoption of renewable energy technologies and a push toward decarbonization can erode the long-term value of Peabody’s assets and decrease future demand.
  • Technological Risks: New energy sources that are more efficient than coal could replace it and destroy its profitability.
  • Acquisition Risk: Acquisitions by nature carry a risk of overpayment for assets that end up yielding less value than anticipated. There is a risk that any new business Peabody acquires will not add value to their core operations.
  • Management Risks: Poor business or financial decisions from the top management can lower profitability and lead to destruction of value.

It is hard to forecast how the global political and economic situation will play out and affect Peabody and the wider coal industry.

Understandability

  • Rating: 2/5
    • Justification: While the business model of selling coal can be described as simple, the way Peabody goes about it is far from simple. The dynamics of the coal market are hard to understand for new investors, and with regulations and politics also playing a part, it makes it harder to understand the company and its prospects. The company also is very levered and it is not very easy to understand if they are using the debt wisely. They also use several complicated accounting measures that obscure the true profitability of the company.

Balance Sheet Health

  • Rating: 3/5
    • Justification: While the company’s cash position is good, it’s debt load and liability obligations give cause for concern. The company’s cash position should be monitored closely in the future. The company is profitable and is generating decent cash flows right now, which is a positive sign.

It should be emphasized, that the company is in a cyclical industry, so it can change very quickly. Investors should make sure that they understand the risks of this industry before investing their capital.