Holding Name: Peabody Energy Corp (NYSE: BTU)
Percent weighting of strategy: ~6.0%
TLDR: All three pillars of our investment thesis in Peabody Energy were on full display following the company's strong earnings results Tuesday that sent the stock +14% higher on the day. We added to this name with conviction ahead of the print as the company continues to fire on all cylinders and heads into 2023 operating at a very high level.
Business overview: Peabody Energy (BTU) is the largest coal supplier in the United States and the second largest coal supplier in the world. Founded in 1883, the company has 32 active mines and 5 billion+ tons of coal reserves split between the U.S. and Australia. The company is characterized by its high-quality assets, leading market share, and compelling unit economics as a low cost producer. Peabody's business is divided across four primary segments:
Powder River Basin | U.S. (29% of revenues)
Seaborne Thermal Coal | Australia (28% of revenues)
Seaborne Met | Australia (22% of revenues)
Other U.S. Operations | U.S. (21% of revenues)
Why we own it: The Russia/Ukraine conflict turbocharged global coal/natural gas supply/demand dynamics, enabling Peabody’s business to become materially transformed as a result. Notably, this change has allowed BTU to capitalize on the elevated price environment and accelerate its free cash flow growth trajectory while also maintaining a strong liquidity profile. Our BTU investment thesis is driven by three main pillars:
Complex capital structure and one-off events overshadowing BTU's strong earnings power.
Peabody’s highly undervalued Wambo Mine + upside growth potential.
Robust free cash flow unlocking BTU's long-awaited shareholder return program.
1. Convoluted Capital Structure: One-off idiosyncratic events such as harsh weather conditions and railroad bottlenecks contributed to the company's underperformance prior to our initiation. These headwinds coupled with BTU’s convoluted hedging structure (a prudent management decision prior to the Russia/Ukraine conflict) had contributed to poor investment sentiment and a drag on stock performance. As the company moves forward from these one-off events and capitalizes on the highly favorable pricing environment, we believe earnings power should grow dramatically.
2. Undervalued Wambo Thermal Mine: BTU’s Wambo mine is one of the best mining assets in the world and should serve as a key driver of future growth. After expanding operations through 2022 and enduring temporary production delays on the back of torrential weather conditions, Peabody now expects the mine to finally be operating at 100% capacity. Given this increased export capacity and very strong pricing environment, BTU should be able to export 4.5 million - 5.5 million tons from its Wambo Mine which we estimate could generate between $1.2B - $1.8B of EBITDA (a fancy way to say profits).
3. Long-awaited Share Buyback/Dividend Announcement: We believe BTU’s capital efficiency plans coupled with increased free cash flow will allow the company to pay down restrictive debt and accelerate its plans to implement a long-awaited dividend/share buyback program for BTU investors. With prior hurdles expected to be cleared in the coming months, we believe this shareholder return catalyst will enable the company to market itself as a high growth + capital return story alongside a lucrative free cash flow yield of 35-50%.
What’s the latest: Our team added to our positioning in BTU on Monday morning ahead of the earnings announcement on Tuesday, February 14th. After generating impressive free-cash-flow over the last several quarters, the company has been able to pay down restrictive debt that had made it difficult for the company to return capital back to investors (components #1 and #3 to our thesis!).
Notably, Peabody produced a strong, beat and raise earnings print which enabled the company “deliver record free cash flow and repay all remaining senior secured debt.” As a result, BTU extinguished the last $545 million of its senior secured debt, and now is essentially debt free alongside $1.3 billion+ in cash on the balance sheet. We expect these strong earnings results will further continue with our free cash flow estimates ranging between $1.5-2.5 billion of FCF for FY23 vs its current market cap of ~$4 billion today.
Signposts moving forward: Management has continued to emphasize the importance of paying down restrictive debt and now actively pursuing negotiations to resolve the company's surety agreement (a promise to pay back IOUs) from years prior. We believe the completion of this agreement should finally open the path up for Peabody to begin returning capital to shareholders in the coming quarters - a tailwind for sentiment and performance moving forward.
The supply/demand dynamics in global energy markets continue to be important dynamics our team is monitoring closely as it relates to BTU. Although favorable today, peace in Ukraine may have an impact on the company’s pricing power and is something that our team is tracking closely.
Lastly, we are also tracking the continued progress/development of BTU's Wambo Thermal Mine alongside ongoing contract pricing negotiations-- this is a key driver of the growth story that we expect to continue for the next several years.
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