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Moody's Cuts Peabody Energy (BTU) to 'Ba3'; Little Improvement Expected in Met, Seaborne Coal in Next 12 to 18 Months

July 23, 2014 2:28 PM EDT

Moody's downgraded the ratings of Peabody Energy Corporation (NYSE: BTU), including its Corporate Family Rating (CFR) to Ba3 from Ba2; Probability of Default Rating (PDR) to Ba3-PD from Ba2-PD; senior secured ratings to Ba2 from Ba1, senior unsecured rating to Ba3 from Ba2, and the junior subordinate debt rating to B2 from B1. Speculative Grade Liquidity (SGL) rating is affirmed at SGL-2. The outlook is negative.

..Issuer: Peabody Energy Corporation

Downgrades:

.... Probability of Default Rating, Downgraded to Ba3-PD from Ba2-PD

.... Corporate Family Rating, Downgraded to Ba3 from Ba2

....Junior Subordinated Conv./Exch. Bond/Debenture Dec 15, 2066, Downgraded to B2 (LGD6) from B1(LGD6)

....Senior Secured Bank Credit Facility, Downgraded to Ba2 (LGD3) from Ba1(LGD2)

....Senior Unsecured Regular Bond/Debenture, Downgraded to Ba3(LGD4) from Ba2(LGD4)

Outlook Actions:

....Outlook, Changed To Negative From Stable

Affirmations:

.... Speculative Grade Liquidity Rating, Affirmed SGL-2

RATINGS RATIONALE

The downgrade reflects the prolonged weak industry conditions for seaborne metallurgical and thermal coal, with little improvement expected over the next 12-18 months, which will especially challenge the company's Australian division. We also expect average realizations in the US to decline in 2014 relative to year prior. Although we expect the company's Western US operations to show improved realizations in 2015, we believe Midwest pricing will remain under pressure as the company's higher priced long-term commitments continue to roll-off.

Although we expect the company to undertake cost containment efforts and non-core asset sales to mitigate the impact on leverage and cash flows, credit metrics will continue to deteriorate and remain weak over the next eighteen months. We expect Debt/ EBITDA, as adjusted by Moody's, of roughly 8x in 2014, with no material recovery expected in 2015. Absent meaningful metallurgical coal market recovery, we anticipate negative free cash flows of $350 - $400 million per year, excluding any proceeds from asset sales. We believe that met coal prices will need to recover to the range of $150 - $160 per tonne for Peabody to return to neutral or positive cash flows.

The stress to Peabody's metrics is predominantly rooted in the company's Australian platform, which does not utilize long term commitments for most of its production (with most metallurgical coal sales made on spot basis or under quarterly contracts), and has suffered the impact of the low pricing environment in the seaborne metallurgical and thermal markets. While generating almost 40% of the company's revenues, the Australian division generated negligible EBITDA in the first two quarters of 2014.

Meanwhile, the third quarter benchmark price for high quality coking coal settled at a level identical to the second quarter, $120 per metric tonne. Already at a six year low (and steeply below the $160 average price in 2013 and the $145 benchmark for the first quarter), metallurgical coal prices look set for a prolonged pricing trough. While we expect that production cuts should bring prices closer to $140 per tonne by the end of 2015, we don't anticipate sustained or substantial recovery beyond these levels for the next few years, due to additional supplies coming online globally. We also expect take-or-pay transportation contracts in Australia will continue to delay production cuts, which will contribute to the softness in prices. Peabody in particular has substantial take-or-pay rail and port arrangements, predominately in Australia, totaling $3.7 billion, with terms ranging up to 26 years and near-term annual commitments of $350 -- 400 million.

The Ba3 corporate family rating reflects Peabody's significant size and scale, broadly diversified reserves and production base, efficient surface mining operations, and a solid portfolio of long-term coal supply agreements with electric utilities. The rating also reflects its competitive cost structure compared to other US-based producers and organic growth opportunities. Challenges for the rating include regulatory and other pressures facing the US coal industry, volatility of the company's Australian operations due to its exposure to metallurgical coal, foreign currency fluctuations, and operational risks inherent in the coal industry.

The company's Speculative Grade Liquidity Rating of SGL-2 reflects Peabody's cash on hand and substantial revolver capacity. At June 30, 2014, Peabody had almost $500 million in cash and cash equivalents, and almost full availability of its $1.65 billion revolving credit facility, which matures in 2018. Peabody's next significant maturity will be $650 million in senior notes coming due in 2016. We expect Peabody to be in compliance with the covenants under its secured credit facility. Peabody has several alternatives for arranging back-door liquidity if necessary. Peabody's large number of mines and its operational diversity across the PRB and Illinois Basin give it the flexibility to sell non-core assets if necessary.

The negative outlook reflects our expectation that any material recovery in metallurgical coal markets is at least eighteen months away, with Peabody's as-adjusted Debt/ EBITDA approaching 8x. While we anticipate that management will continue cost containment efforts and initiate asset sales to mitigate the impact on cash flows, the negative outlook reflects our expectation that the company is likely to burn cash over the next eighteen months.

Although an upgrade is unlikely in the near term, the outlook could be stabilized if the company was expected to remain cash flow neutral and Debt/ EBITDA, as adjusted, was expected to trend towards 4x.

A downgrade would be considered if Peabody's liquidity position deteriorated, free cash flows were persistently negative, debt capitalization ratio was expected to persistently track above 65%, and/or Debt/ EBITDA, as adjusted, was not expected to track towards 5x over the next two to three years.

The principal methodology used in this rating was the Global Mining Industry published in May 2009. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.



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