IEEFA Update: Peabody Investors Are in for a Bumpy Ride
Investors are in for a bumpy ride as Peabody Energy fashions its reorganization and emerges from bankruptcy. The company’s stock price has been volatile over the past two weeks, capturing the attention of hedge fund investors who have acquired a 5 percent stake in the company.
The stock rose from $1.74 per share to over $10 per share during the week of October 17. Then last week, it climbed even higher at one point – to $18.75 per share, on October 24th – and ended the week close to where it started on Monday, at around $8 per share.
But, coming back to earth for a moment, none of this means that the fortunes of the coal company have turned the corner. In fact , most of Peabody’s monthly financial reports since May show operating losses prior to debt and bankruptcy related expenses (the company declared bankruptcy in April).
And in a filing with the Securities and Exchange Commission on October 20, the company continued to say, as it has done since June, that its equities and other securities could be worth nothing upon disposition of bankruptcy:
“It is uncertain at this stage of the Chapter 11 Cases if any proposed plan of reorganization would allow for distributions with respect to Peabody Energy equity or other securities. It is likely that Peabody Energy equity securities will be canceled and extinguished upon confirmation of a proposed plan of reorganization by the Bankruptcy Court, and that the holders thereof would not be entitled to receive, and would not receive or retain, any property or interest in property on account of such equity interests. In the event of cancellation of Peabody Energy equity or other securities, amounts invested by the holders of such securities would not be recoverable and such securities would have no value. Trading prices for Peabody Energy’s equity or other securities may bear little or no relationship during the pendency of the Chapter 11 Cases to the actual recovery, if any, by the holders thereof at the conclusion of the Chapter 11 Cases. Accordingly, Peabody Energy urges caution with respect to existing and future investments in its equity or other securities.”
These reports are filed for compliance with bankruptcy rules and not intended as information to investors that would be consistent with SEC reporting requirements. And some of the language reflects cautious “lawyering.” That said, the fact remains that the ultimate value of Peabody’s common shares is uncertain.
More important, the recent stock price improvement does not appear to reflect an improvement in the company’s market fundamentals. Although there is a lot of noise about the company charting a more profitable path, Peabody still acknowledges its stock may be worthless upon emergence from bankruptcy, a factor likely to impact how the company approaches both equity and debt markets in the future. The company has recently received an extension on its filings in bankruptcy court, undoubtedly hoping to emerge from bankruptcy with an even stronger tailwind from metallurgical and thermal markets in the U.S. and abroad.
Peabody’s valuation through the bankruptcy process is very much on the minds of hedge fund investor Mangrove Partners, which disclosed last week that it has acquired a 5 percent stake in the company. Mangrove Partners has expressed interest in forming an equity committee—a decision that will be up to the U.S. Trustee and/or the judge in the bankruptcy proceeding. Peabody has not publicly commented on the matter.
SO WHAT OF THE RECENT SIGNS OF “MARKET IMPROVEMENT” – MEASURED BY INCREASES IN THE PRICE OF COAL – WIDELY HAILED BY THE COAL INDUSTRY?
It’s true that prices for metallurgical coal have spiked recently, to $209 per ton in September, causing a coal industry buzz about the potential for reviving exports from the U.S. But an export bump, as it were, will last only as long as the price spike does. Wood Mackenzie, typically bullish on coal, expects prices to fall and level off around $130 per ton, and predicts competition will rise in the Asian met coal market. IEEFA’s view is the the U.S. coal-export industry is a niche player and that when U.S. exports increase it usually means the global market is past its peak. We will see this view tested in the coming months.
Coal industry leaders like Arch Coal have told investors in the past that a focus on metallurgical coal would begin to spark a renaissance for the company. But Arch Coal’s 2011 plan that promised 15 million tons of metallurgical coal sales by 2015 never materialized.
Peabody inked a deal in October to sell metallurgical coal from Australia to Japan’s Nippon Steel for the fourth quarter 2016. The deal set the price of coal at $200 per metric ton—higher than that seen over the past several years, and could be good news for Peabody’s Australian operations. Several major policy decisions in China will determine the extent and duration of the pricing.
Some industry analysts are seeing signs of life in the U.S. thermal domestic coal market, citing a slowdown in the rate of decline in production, higher natural gas prices providing an uptick to market share, rising prices and lower stockpiles in some regions.
But it may just be a case of “been down so long it looks like up to me.”
Annual U.S. thermal coal production is likely to drop by more than 100 million tons, from 2015 to 2016. Natural gas prices are now at $3/mmbtu, up from the $2 range, but still far below a level that would promote investment in coal-fired power. The price of coal is going up somewhat, but as Peabody Energy implies in its outlook, this does not amount to rising equity values, much less any incentives for banks to return to lending to the coal industry. Coal producers and long-term investors will require more than a few weeks of rising prices to begin increasing production and opening closed mines. Diminished stockpiles at power plants, once a solid indicator of future demand, may no longer be a reliable market signal as new purchasing norms related to the changing competitive mix of generation fuels take hold.
The bottom line is that coal-fired power plants are continuing to close in the U.S., causing the markets to shrink further. Recent IEEFA reports include one that shows how Texas, which historically has been the largest consumer of coal in the nation, is likely to close more coal-fired power plants in the coming years. The coal industry has argued that coal plant capacity factors would increase as some plants close, but this hasn’t been true in Texas. Increased competition from wind, solar and natural gas is altering the electricity landscape. This will have a profound effect on mines in the Powder River Basin, as we explained in a separate report a few weeks ago, where Texas coal plants have been the biggest customers of mines owned by Peabody and other major coal companies.
Even as they emerge from bankruptcy, we see Peabody and other coal companies entering into a new cycle of financial stress. Despite having billions in dollars of debt expunged, the companies are still likely to have difficulty turning around under new financial management.
Notwithstanding Mangrove’s attempt to resurrect some equity value from the ashes, Peabody—in its recent SEC filing—is telegraphing the bad news that awaits around the corner.
Tom Sanzillo is IEEFA’s director of finance.
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