Peabody: Investing In The Stock Again (NYSE:BTU)

Investment thesis: After a strong run last year, on the back of high coal prices, Peabody’s (NYSE:BTU) stock price has seen a significant pullback of about 1/3 from last year’s highs. It mostly happened on the back of a step back in profits in the first quarter of this year, from the fourth quarter of last year. It is also due in part because of the pullback in the global commodities price index from all-time highs last year, within which coal prices in particular took a significant hit. The way I see it, the global energy supply/demand balance remains relatively tight, despite the significant deceleration in global economic growth. Global coal demand will therefore remain strong, as continued tightness in global natural gas supplies inevitably tends to result in more coal demand for electricity generation as well as in a few other industrial activities. After selling my Peabody stock near $30/share last year, I am now cautiously building a position again, with the intent to add in the event that the stock declines further from current levels.

Peabody remains profitable, but the first quarter of this year showed a steep decline in net earnings.

For the first quarter of this year, there was a significant drop of more than half in net earnings, compared with the fourth quarter of last year. It should be mentioned however that net earnings of $269 million for the first quarter of this year is a far more pleasant result than the net loss of $120 million for the same period in 2022. In the fourth quarter of 2022 there was a net benefit in terms of its tax provisions of just under $60 million, while for the current quarter, it was on the hook for $118 million. This one item alone accounts for almost $180 million of the total difference between the $632 million in net earnings in the fourth quarter, and the much more underwhelming result for the latest quarter.

Some major operating factors that arguably made a difference in its financial results include a decline in seaborne coal sales of about 1.2 million tons for metallurgical and thermal coal. It is a decline of about 20% in sales volumes for these categories that sold for $221/ton and $97/ton respectively. Its Powder River coal, which sells for only under $14/tonne made up about 82% of its total sales volume. There was a slight increase in the sale of this low-priced coal with thin profit margins. This accounts for a 16% decline in revenues compared with Q4 of last year. On revenues of $1.364 billion, profit margins were just under 20%, which is still healthy, despite the significant decline in profits compared with the previous quarter.

Global commodities prices softened recently, but we may see a reversal, despite the low economic growth projections.

One of the reasons for the drop in Peabody’s stock price in the past few months seems justified by the overall decline in the global commodities price index.

It is reasonable to assume, based on the GDP forecasts, as well as the global commodities price action that global coal demand, therefore Peabody’s fortunes going forward may be less than stellar. We should keep in mind that given a choice of shutting down a natural gas-powered turbine or a coal-powered one, coal tends to lose out, mostly because of climate change and other environmental concerns, since coal consumption leads to much higher emissions and it also tends to pose a local health hazard due to chemicals that are released into the air.

Despite the gloomy economic outlook for this year and next, global commodities prices are still holding up quite well if we take a closer look at the price index chart above. We are still close to the price levels we saw during previous price spikes. Going forward, there are now some forecasts that suggest a return to higher oil prices, as the global supply/demand balance shifts into deficit in the second half of the year based on IEA and other forecasts.

Taking a closer look at the global economic slowdown we have forecast for this year and next, from last year’s already underwhelming levels, it is important to look at the advanced economies and the developing world separately. As the IMF forecast suggests, most of the decline in global economic growth will come from the developed world this year and next. The developing world is hardly seeing any decline in growth this year, while next year it will see a slight acceleration above 2022 growth rates.

This is important because economic growth in the developing world tends to be more energy-intensive, as it involves more infrastructure building, and more transport growth, both commercial and personal. For this reason, we are not seeing the massive demand destruction for energy & commodities that one might expect to see as a result of global economic growth dipping under 3% this year, and perhaps next year as well. Developing nations are also less likely to choose natural gas over coal, especially if natural gas supplies trade at a premium over coal, as tends to be the case with LNG.

Hope for a global surge in economic growth is not lost.

Things are not looking particularly bright at the moment in terms of global economic growth prospects, which is a crucial aspect of the positive Peabody investment thesis. There is a worsening geopolitical environment, with confrontational attitudes spreading among the largest and most important economies. There is a potential banking crisis, which is just a symptom of the spike in interest rates, after a decade of very low rates. There are many other problems contributing to a lackluster economic growth environment currently, and also to a gloomy forecast going forward. But as always, things can always change and do so surprisingly fast.

In my view, a quick turnaround in the geopolitical situation would be key to getting the global economy back on track. Trade, economic, and tech competition tensions with China are currently contributing factors to persistent inflationary pressures. If China were to fire on all cylinders and flood the global market with manufactured goods, it could certainly help to reduce inflationary pressures. A quick resolution to the Ukraine war would help as well. Russia is the world’s largest net exporter of commodities ranging from food to oil, as well as semi-finished goods derived from hydrocarbons, like fertilizers and so on. A full resumption of normalized trade between Russia & the World could provide higher growth as well as act as a further dampener to inflation.

If inflation were to slow sufficiently, we could see an easing in the monetary policy of key central banks like the US Federal Reserve, as well as the ECB. It would not only lead to higher growth as money and credit becomes more affordable, but it would in theory also ease the pain of certain banks and other institutions that are currently sitting on low-yielding debt paper, they purchased between 2009-2021 when rates were low and now are worth less, because no one wants to be sitting on low-yield investments, when better yields can be gained from current debt that is being issued.

In short, something that is entirely in the control of major global leaders can be fixed in the interest of improving the global economic outlook, and it could potentially be done in short order. It does not mean that any such event will take place, in fact at the moment things seem to be headed in the opposite direction, and in my own view, it is very unlikely that we will see an easing of global geopolitical tensions this year, and perhaps even next. It is nevertheless important to understand that the possibility is there and to also grasp just what a massive positive potential effect it could have on a global economic recovery.

In the event of a sudden upshift in economic activities that would boost energy demand, coal prices could potentially rally accordingly in response.

I do not necessarily think that we will revisit the high price of coal we saw last year. However, even a slight improvement in the global economic outlook can help to stabilize coal prices at or near current levels, followed by a reversal higher.

Investment implications:

As I pointed out in an article at the beginning of 2022, I decided to buy Peabody stock, which was then trading at less than $12/share. I sold the entire position as it approached $30/share last year. As its stock price approaches $20/share I decided it is worth taking a small nibble, with the intent to buy more in the event that it breaks well below $20. Caution should be exercised, because the odds are in favor of coal prices, therefore Peabody’s stock price going lower from here, given all the potentially negative factors that can potentially greatly curtail global energy demand this year and potentially beyond. Just in case it does not turn out the way that the market increasingly expects, in other words, we will see a significant global economic slowdown this year and perhaps beyond, I took up this rather timid position in Peabody stock, to make sure that I will not miss out entirely.