Description

Thesis

Peabody Energy (BTU)’s equity is worthless. In last week’s melt up in junk energy equities, BTU’s share price increased over 53% increasing the company’s market cap to over $63 million. In contrast to the bullishness in the equity market, the company’s bank debt continues to trade below 40% of par, its second lien bonds are trading around 3% of par and its senior unsecured bonds are trading below 3% of par. While the equity markets are valuing Peabody at over $8.8 billion, the bank debt market is valuing the company at $820 million (assuming the bank debt is treated senior to pension, opeb, environment, and other liabilities), and the second lien bond market is valuing the company at $2.2 billion (using the same assumptions.) With $70 million in interest payments due on March 15th and the company having already drawn all of its revolver making incremental liquidity especially scarce, we expect BTU to skip those interest payments and file for bankruptcy in the next 6 weeks. With net debt (excluding legacy liabilities) over 15x 2015 EBITDA and EBITDA expected to decline in 2016, BTU shareholders have little to no hope for any equity recovery. We recommend shorting shares to the extent borrow is available or buying April put options as the stock is likely to fall to near $0 on the bankruptcy filing.

Company Overview

Peabody Energy is the largest private coal company in the world. Peabody is mainly an open pit miner with both thermal and metallurgical coal production from 26 mining operations in the United States and Australia. The company has 8300 employees, 40% of which are unionized.

Total U.S. thermal Coal demand declined by 110 million tons in 2015 due to mild winter weather and depressed natural gas prices. Coal declined to 34% of US electricity vs. 40% in 2014. Peabody now expects U.S. coal demand to fall a further 40 to 60 million tons in 2016. Coal production is currently down roughly 30% year over year through the end of February.

BTU’s most important domestic mine is the North Antelope Rochelle mine in the Powder River Basin in Wyoming. PRB coal prices remain depressed around $10/ton as PRB inventories at coal power plants are currently over 100 days versus normal levels around 50 days. Given this backdrop it is unlikely that PRB coal prices recover materially in 2016.

Metallurgical coal prices remain at multi year lows due to weak global steel demand. Given the outlook for continued weak Chinese and other emerging market economic growth, steel prices and metallurgical coal prices are unlikely to recover materially in 2016.

Peabody reported 2015 EBITDA of $435MM, a 47% decline from 2014’s EBITDA of $814MM. Peabody’s operations are being impaired by low demand and weak pricing for metallurgical coal due to the weak Chinese economy as well as the collapse in demand for U.S. thermal coal due to the collapse in natural gas prices.

Peabody’s recently released Q4 2015 earnings were a complete disaster. The company reported EBITDA of $53 million missing sell side estimates of $115 million. The bulk of the miss came out of weak performance in the company’s domestic operations as well as a significant decline in the profitability of the company’s coal trading business. The company cut its 2016 coal production guidance by 13% due to reduced utility and sea borne market demand.

Concurrent with its Q4 earnings release, BTU revealed that the company had tapped all of its available revolver capacity; a step which usually precedes a bankruptcy filing.

Peabody has provided the following guidance for 2016.

It is worth noting that BTU’s 2016 guidance includes an assumption that its 116mm tons of PRB coal production will be sold for contracted prices of $13.30/ton. This is materially above current spot prices (~$9.70/ton) and suggests that BTU’s price realizations are likely to fall in future years unless there is a material change in the PRB coal market. PRB coal is uneconomic when natural gas prices are below $2.50 per mcf. Natural gas is currently around $1.67/mcf. Unless natural gas prices rally materially there is likely a ceiling on any potential upside in PRB coal prices.

Capital Structure

Coal companies normally trade between 5x and 8x EBITDA. For Peabody’s equity to have any value, EBITDA would likely need to be over $1.1 billion vs. 2015 EBITDA of $435MM and 2016 estimated EBITDA of $300MM.

BTU’s bank debt and bonds are already pricing in a massive restructruing.

BTU’s bank debt has been declining consistently since late Octomber and currently trades at 38% of par.

BTU’s second lien bonds trade around 3% of par, lower than the 5% interest payment that would be due to them on March 15th.

Likewise, the unsecured bonds trade at 3% of par, less than the 3.25% interest payment due to the 6.5% bonds due 2020 on March 15th.

With roughly $450 million in cash interest payments vs. 2015 EBITDA of $435MM and estimated 2016 EBITDA of around $300 million, BTU’s balance sheet is unsustainable.

If BTU were to choose to continue to make interest payments on its debt, the company would burn through roughly $550 million in 2016. Peabody’s bank lenders are better off with the company using the liquidity from the recently drawn revolver to fund operations during a bankruptcy than they would be if they allowed Peabody to burn cash for another year and then use DIP financing in a bankruptcy. Leverage through the first lien debt is over 7x our estimate of 2016 EBITDA before giving effect to any DIP facility. Given this, we do not expect Peabody’s banks to grant the company waivers from the various covenant defaults it is about to incur.

For the last few months, BTU has been talking to various groups of bondholders in an attempt to arrange an exchange offer of cash and new more secured notes in exchange for a significant reduction in principal. On February 29th, BTU released an 8-k where it revealed that one of its first lien lenders (subsequently revealed by Bloomberg to be Franklin Resources – owners of ~20% of the term loan) is concerned with BTU’s attempt to do an out of court restructuring. Franklin is pushing the company to file for bankruptcy.

Moreover, BTU is in the middle of a liquidity crisis. Liquidity dropped to $903 million as of February 9th down from $1.81 billion at the end of Q3 2015, and $1.2 billion at the end of Q4 2015. BTU drew the remaining $120 million of unused capacity on its revolver on February 12th. Peabody is required to make a $250 million lease payment to the Federal government in the second half of 2016 as well as a $75 million payment to a VEBA related to Patriot Coal’s first bankruptcy. Peabody currently self bonds $1143 million in reclamation liabilities at its U.S. mines. BTU was forced to increase its letters of credit outstanding from $229 million at the end of Q3 to $824 million at the end of Q4. Should state and federal regulators get more concerned about the company’s precarious financial situation, they could force the company to post additional cash collateral to secure the asset retirement obligations. A 25% collateral requirement would require $285 million in cash. The company is highly unlikely to sacrifice its remaining scarce liquidity in order to pay interest payments on its existing bonds.

Peabody does have some sources of potential liquidity. In November, BTU announced plans to sell its New Mexico and Colorado assets to Bowie Resource Partners, LLC for $358 million. Bowie has had difficulty raising financing to close this transaction as its attempts to issue a $650 million term loan in February failed. Commitments for the term loan were due February 8th and were insufficient to close the transaction. Given the collapse in high yield energy and especially coal company bond and term loan prices over the last 3 months, we find it highly unlikely that Bowie will be able to raise the financing to close this transaction. The Bowie divestiture transaction has a $20 million termination fee in the event Bowie is unable to raise financing. Peabody’s plans for a debt exchange offer with bondholders are contingent on the closing of the Bowie transaction. The Bowie asset sale agreement terminates if it does not close by March 31st.  Even if the Bowie transaction closes, it would only buy Peabody an extra 3 to 6 months of time to negotiate its inevitable debt restructuring.

In January BTU announced the sale of its interest in the Prairie State Energy Campus for $57 million. This transaction is expected to close in H2 2016.

On February 29th, BTU filed an NT-10k indicating that if the company is not able to close the Bowie divestiture in the coming days, it would be forced to include a “going concern” audit opinion in its financial statements which would constitute an event of default under its credit facility. BTU has stated that it expects to file the Form 10-K by March 15th (i.e. within the 15 day period prescribed in Rule 12b-25.) The NT-10k filing included the following language:

If the Company’s reported Adjusted EBITDA, which is defined in Exhibit A, and other sources of earnings or adjustments used to calculate Consolidated EBITDA, as defined in the Company’s senior secured credit agreement entered into in 2013 (as amended, the “2013 Credit Facility”), falls below its Consolidated Net Cash Interest Charges, as defined in the 2013 Credit Facility, during 2016, the Company will not be in compliance with its Consolidated Interest Coverage Ratio, as defined in the 2013 Credit Facility. Other sources of earnings or adjustments to the Company’s reported Adjusted EBITDA provided for under this covenant may include, in certain instances, cash proceeds from asset monetization activities. The receipt of proceeds from the Transaction described above is a substantial disposition of assets that impacts the Company’s forecasted covenant compliance and its independent registered public accounting firm’s going concern assessment. Based on an analysis of a range of 2016 financial projections and continued coal market deterioration, the Company believes there is substantial doubt as to whether the Company can comply with its financial covenants under its 2013 Credit Facility without consummation of the Transaction.

Unless the Transaction is consummated before the issuance of the Company’s audited financial statements for the year ended December 31, 2015, the Company believes its independent registered public accounting firm will be required to issue an audit opinion with a going concern uncertainty paragraph. Further, the inclusion of an audit opinion with a going concern uncertainty paragraph within the Company’s financial statements would constitute an event of default under the credit agreement governing the 2013 Credit Facility after the expiration of any applicable grace period.

If the Company experiences or expects to experience a financial covenant breach or other default, it could request an amendment to, or waiver of, the covenant from its lenders. If the Company is unable to obtain waivers from its lenders, the 2013 Credit Facility and certain of its other debt arrangements would be in default and the debt owed under such agreements could be accelerated.

Due to the impact of the Transaction on the Company’s financial statements, the related audit opinion and the required Form 10-K disclosures and their consequent impact on the Company’s compliance with the terms and covenants of its 2013 Credit Facility, the Company is unable to file the Form 10-K without unreasonable effort or expense. The Company expects to file the Form 10-K within the time period prescribed in Rule 12b-25 promulgated under the Securities Exchange Act of 1934.

Catalyst

BTU elects to skip the ~$70 million in interest payments due on March 15th related to its 6.5% Senior Notes due 2020 and its 10% second lien notes due 2022. The missed interest payment constitutes an event of default under those notes and by consequence an event of default under the company’s credit facility. Sometime during the 30 day grace period after the missed interest payment, BTU will either file for bankruptcy or its lenders will force it into bankruptcy. Note: BTU has a $24 million interest payment due on its term loan on March 31st.

Alternatively, the asset sale to Bowie Resource Partners fails to close by March 15th forcing BTU to issue its 10K with a going concern qualification creating an event of default under the company’s term loan and revolver. The bank lending group then pushes the company into bankruptcy.

Catalyst

BTU elects to skip the ~$70 million in interest payments due on March 15th related to its 6.5% Senior Notes due 2020 and its 10% second lien notes due 2022. The missed interest payment constitutes an event of default under those notes and by consequence an event of default under the company’s credit facility. Sometime during the 30 day grace period after the missed interest payment, BTU will either file for bankruptcy or its lenders will force it into bankruptcy. Note: BTU has a $24 million interest payment due on its term loan on March 31st.

Alternatively, the asset sale to Bowie Resource Partners fails to close by March 15th forcing BTU to issue its 10K with a going concern qualification creating an event of default under the company’s term loan and revolver. The bank lending group then pushes the company into bankruptcy.