Tuesday, June 10, 2008

Peabody Energy Does Not Need Santa's Help With Coal Sales

Peabody Energy (BTU-$79.25), one of the world’s largest coal producer, provides more than 10% and 2% of the total electricity demand in the domestic and global markets, respectively. BTU's customers are utilities (accounted for 85% of sales), steel producers, and industrial companies.

With reserves of nearly 10 billion tons, BTU produces 240 million tons of coal a year from 32 mines in the US and Australia.

US based coal producers benefit from a weaker USD as it makes US coal less expensive vs. countries with stronger currencies. Coal is a vital resource to the country’s energy needs as it accounts for more than half the electricity generated in the U.S.

An estimated 267.6 billion short tons puts US as the largest known coal reserve holder, while China is the world’s largest coal producer and accounts for over a third of the coal mined worldwide.

Growing Demand

The International Energy Agency (IEA) estimates coal’s share of total world energy consumption is projected to increase from 25% in 2005 to 28% through 2030, and in the electric power sector, its share is estimated to rise from 43% in 2004 to 45% in 2030.

BTU - alongside its comparables Consol Energy (CNX), Arch Coal (ACI), Massey Energy (MEE) - have been on a tear of late, driven by demand from thermal coal markets and short and long-term factors, such as:
  1. production delays (Australia, world's largest exporter of coal, for BTU which saw revenues drop 93% due to flooding);
  2. drop in coal inventory levels at power utilities (i.e. South African exporters are 2.5 million tonnes lower YTD and the local utility companies announced a need to rebuild inventories by 45 million tonnes over the next two years);
  3. consumption demand, especially from the steel industry and developing countries (i.e. India, where coal demand, as forecasted by IEA, is expected to nearly triple by 2030). In total, global coal consumption is expected to grow 73%, or more than 4 billion tons by 2030;
  4. new global coal generation (e.g. new coal-fired electric plants under construction in the U.S. are expected to increase coal consumption by 50 million tons and new generating plants are under planning and construction in more than 70 nations);
  5. alternative energy supplies fall short or aren't developed to fully supply the market for now;
  6. major coal exporting nations retain more coal for domestic use (i.e. Indonesia and Russia);
  7. demand from Japan due to a nuclear reactor being shut down following an earthquake;
  8. China increasing coal imports as it has been adding thermal power plants to its generation fleet, as well as a series of snowstorms early in the year, thus reducing the delivery of coal from mines in northern China to power plants across the southern and western regions
  9. Coal-to-Liquids projects, such as developmental deals to transform coal to diesel and jet fuels.

More than 80% of the growth in global coal demand is expected to come from China and India. These two countries comprise approximately 45% of global coal use, which is projected by IEA to grow to 80% by 2030.

"We believe strong coal markets will continue worldwide, as long as growth continues in the US, Asia and other industrialized economies that are increasing coal demand for electricity generation and steelmaking." BTU Management, latest 10Q filing.


BTU's Q1 2008 total revenues increased $166.2 million, 15% YoY, to $1.28 billion thanks largely to higher volumes in the Powder River Basin and improved pricing from all domestic regions.

In Q1, BTU also benefited of a gain of $54 million from the sale of non-strategic coal reserves and surface lands located in Kentucky. Investors should note that BTU has off-balance sheet arrangements and hedging activities with VaR for their coal trading portfolios at approximately $50 million.

While some of the smaller met coal U.S. producers have outperformed BTU YTD—unlike BTU they are not likely to see much of an increase to 2008 estimates. Peabody had by far the most exposure of any producer to record benchmark prices, since it was easily the most unhedged met coal producer as of the beginning of this year.

Price Catalysts

Upcoming catalysts for BTU include the El Segundo Mine in New Mexico, which is a 6-million ton/year operation and is expected to be highly productive, with an overburden ratio approximately half of the neighbouring Lee Ranch Mine. With the addition of El Segundo, Peabody's New Mexico production should grow to nearly 10 million tons in 2010 from 5.8 million tons in 07.

The floods in the Australian (Queensland) subsidiary of BTU led to decrease in EBITDA by 94%/$58.7 million vs. last year. Once the Australian operations are back online, full utilization by Q4, BTU’s decision in 2006 to substantially increase its Australian exposure with the purchase of Excel Coal will begin to pay dividends.

Contributor Yaser Anwar does not hold a financial position in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure policy.

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