Kerrisdale Capital Investment Case Study Spring 2015 Competition – Peabody Energy Corporation (BTU): From Hero To Zero
H/T ActivistShorts
1. Company Overview and brief market analysis
Peabody Energy is the world’s largest private-sector producer and distributor of coal. Present in 25 countries, this company produces thermal coal for power generation as well as metallurgical coal used in producing steel. The company has been struggling with deteriorating prices, as the demand for coal was hit by low natural gas prices, increasing use of alternative energy sources and the global drive to reduce carbon emissions by cutting coal and other fossil fuel generated energy consumption.
The company currently provides 10% of the electricity generated in the US and 2% of the energy around the world. Peabody Energy is the market leader in the U.S. providing 18.6% of the total volume of coal produced (cf. Table 1) – an equivalent to 183 275 thousand tons in 2013.
Peabody operates through the entire value chain, from mining the coal, to selling and distributing it for electricity production and steelmaking. Peabody Energy also markets, brokers and trades coal in the world’s fastest-growing economies.
Analysing the US market, a very relevant market for Peabody Energy due to its market size and overall Peabody Energy exposure, we can clearly see that the whole sector is suffering profound changes. At a first glance all but one of the top 4 producers show very negative net incomes, and all of the companies are disinvesting heavily, which can seriously injure future profits by limiting the companies’ size in a capital-intensive sector. All the larger companies face lower gross margins than the sector average, which could be a sign of how difficult it is for these companies to reduce their size without compromising future growth, due essentially to the weight of Capital Expenditures in the business model.
“Current prices are eliminating profit margins for a growing number of coal producers. […] Over half of China’s coal producers have cash costs in excess of domestic Chinese spot prices, and throughout the US higher cost miners are currently producing at a loss.” – according to Carbon Tracker, a financial specialist concerning carbon investments.
Peabody’s current production and distribution is concentrated in the U.S. and Australia, as we can see in the Figure 1. This geographical segmentation is severely pressuring the company. On one side, U.S. and Australian markets are more mature economies, with increased pressures to reduce carbon emissions and bringing up competitive energetic alternatives like Natural Gas or renewables, or event the recent game changers Shale Gas and Oil. Fast-growing markets like China or India tend to value price and efficiency whilst caring less for carbon emissions in this stage of development, but these developing countries already have local producers which are better positioned in a scenario of higher concentration of Coal consumption worldwide. Exporting to these markets will remain a challenge due to: (1) stronger currency; (2) low to unexisthent local presence when compared to local competition – in markets with higher market entry barriers than most developed countries; and (3) shipping costs.
In its current geographies, Peabody Energy faces fierce competition in the coal mining market (Table 2). There are huge players like BHP Billiton, Rio Tinto, Glencore and China Shenhua Energy Co Ltd, most of them with higher EBITDA margins and well diversified in the energy sector. Moreover, being China one of the most important markets for coal mining we should note that this market already has well established strong players – like China Shenhua Energy Co Ltd, the world’s largest coal mining enterprise. Due to that fact, Peabody Energy should not take the expected growth in the Chinese coal market as granted, since it won’t be that easy to appropriate the piece of the cake that could ensure some revenue. Actually, in 2014, Chinese coal imports declined 35 million tonnes, since China itself faced oversupply, with the Chinese Government intervening to close some facilities in order to keep prices stable.
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