Peabody Energy (BTU) Misses Q2 EPS by 2c

"Peabody accelerated a number of initiatives in the second quarter to reduce operating costs, create a leaner organization and optimize our portfolio," said Peabody Energy President and Chief Executive Officer Glenn Kellow. "As we manage through extended low-cycle market conditions, Peabody is taking aggressive actions on multiple fronts to preserve and enhance long-term value."

GLOBAL COAL MARKETS

In the second quarter, seaborne and U.S. coal pricing declined, reflecting slower global economic growth, declining steel demand and weak U.S. natural gas prices. In response, U.S. and seaborne supply reductions are occurring, with shipment declines accelerating in several regions.

Within seaborne metallurgical coal markets, the third quarter metallurgical coal benchmark for high-quality low-vol hard coking coal declined 15 percent to $93 per tonne as slowing global economic growth and declining Chinese steel demand offset growing metallurgical coal imports in India and additional supply reductions. The third quarter low-vol PCI benchmark fell from $92.50 to $73 per tonne on reduced blast furnace capacity utilization of 72 percent. In seaborne thermal markets, prices remain constrained due to a 3 percent decline in China's thermal coal generation through June, and a corresponding 51 million tonne decline in China's thermal imports that more than offset import growth of 23 million tonnes in India.

Third-party reports suggest that, at current prices, nearly 80 percent of Chinese metallurgical coal producers are not covering cash costs. The company also believes that limited industry capital investment in recent years will prove insufficient to maintain seaborne metallurgical coal production levels over time. Additional metallurgical coal production curtailments are occurring, and seaborne supply is now expected to decline 15 million tonnes to under 300 million tonnes in 2015. At the same time, thermal coal supply cutbacks are continuing. Through June, Indonesian exports were down 17 percent, U.S. thermal coal exports were down 39 percent and additional global cutbacks are expected.

Within U.S. coal markets, coal generation declined 14 percent through June due to lower natural gas prices. Peabody believes U.S. coal demand will decline 90 to 100 million tons in 2015, with coal projected to comprise approximately 35 percent of total U.S. generation. U.S. coal exports declined 14 million tons through June, and are anticipated to drop by 30 to 35 million tons in 2015. U.S. coal supply decreased 13 percent in the second quarter, and additional production cutbacks are expected in the second half of the year.

Recently, the U.S. Supreme Court invalidated the Mercury and Air Toxics Standards rule regulating power plant emissions, and required the Environmental Protection Agency to properly consider the cost of the regulation. While this ruling is not expected to materially impact planned plant closures or near-term coal demand, the company believes the decision sends a strong message regarding regulatory overreach that will prove beneficial when considering proposed regulations impacting U.S. coal generation.

By 2017, Peabody expects that approximately 55 gigawatts of U.S. coal-fueled generation will retire, with the majority occurring in 2015, and that 250 gigawatts of coal-fueled generation will remain online. While total U.S. utility coal demand is expected to decline approximately 30 to 50 million tons between 2014 and 2017 on lower assumed natural gas prices, PRB and Illinois Basin demand is expected to more than overcome 2015 declines by 2017 as these regions retain a fundamental delivered cost advantage over other U.S. coal basins.

PEABODY ADVANCING IMPROVEMENT ACROSS FOUR AREAS OF MANAGEMENT

Peabody continues to take aggressive action to improve the organization and respond to current market conditions across four key areas of management emphasis:

• Operational Excellence: Peabody is implementing a series of actions at its operations to increase productivity, decrease costs, improve cash flows and reduce coking coal and low-vol PCI volumes given current market conditions. The company now targets a workforce reduction of more than 300 positions across multiple mines in Australia, and is lowering metallurgical production by approximately 3 million tons per year. Actions include reducing annualized metallurgical coal production by 1.5 million tons at the North Goonyella Mine, 1.2 million tons at the Coppabella Mine and 600,000 tons at the Metropolitan Mine. The company reduced its 2015 metallurgical sales target by approximately 1 million tons to reflect the remaining impact of lower production and inventory sales.
• Lean Organization: The company initiated the reduction of approximately 250 corporate and regional positions to create a leaner organization and lower costs. When fully implemented later this year, these reductions are expected to save $40 to $45 million per year. These reductions represent approximately 25 percent of corporate and regional support positions, and the majority of the reductions occurred in the second quarter. Actions also include delayering the organization and closing offices in Evansville, Indiana and Gillette, Wyoming. After a 30 percent reduction in second quarter SG&A to the lowest level in eight years, Peabody is targeting more than a 20 percent improvement in 2015 SG&A.
• Portfolio Management: Peabody completed approximately $35 million of non-core asset sales in the U.S. and Australia over the last several months. The company is aggressively reviewing additional portfolio optimization opportunities, and will continue to increase divestment actions in the second half of 2015 through sales of non-core reserves, surface lands and other properties.
• Financial Strength: The company is pursuing multiple avenues to maximize near-term liquidity and is targeting reduced leverage over time. Peabody benefits from lower annual cash payments in 2017 related to completion of PRB reserve installments, lower health benefit trust payments, and potential lower currency rates and fuel prices as legacy hedge transactions roll off. The company also has no significant maturities until late 2018. As part of the plan to maximize liquidity, the board of directors decided to suspend the company's quarterly dividend on shares of its common stock, and will evaluate whether to reinstate the dividend in the future as circumstances warrant. The board of directors also authorized a reverse split of common stock, subject to shareholder approval. If the reverse stock split is implemented, the number of authorized, issued and outstanding shares of common stock would be reduced in accordance with the exchange ratio selected by the company, among five alternative ratios between 1-for-8 and 1-for-20 as approved by shareholders.

OUTLOOK

Peabody's 2015 U.S. production is fully priced with 2016 U.S. production approximately 30 to 40 percent unpriced based on 2015 production levels. During the second quarter, the company priced 14 million tons of PRB coal for delivery in 2016, and now has 89 million tons of PRB priced at $14.23 next year.

U.S. costs per ton are targeted to improve 3 to 5 percent in 2015 as a result of a higher percentage of PRB shipments, lower fuel costs and ongoing cost containment. PRB costs are targeted to remain at approximately the same level as 2014, resulting in a modest PRB margin improvement. U.S. revenues per ton are targeted to decline 3 to 5 percent in 2015 as a result of change in mix and roll off of higher sales contracts compared to 2014, primarily in the Midwest. Australian costs per ton are targeted to be nearly 20 percent below 2014 levels due to cost reduction initiatives, sales mix, and lower currency and fuel expenses. Selling and Administrative Expenses are targeted to be more than 20 percent below 2014 levels due to implementation of a leaner organizational structure and lower third-party spending.

Compared with the second quarter, third quarter Adjusted EBITDA is expected to reflect lower seaborne metallurgical coal pricing, higher PRB shipments as a result of lessened weather-related impacts, and a longwall move in Colorado.

By early 2017, Peabody expects to realize an improvement in annual cash outlays as a result of $275 million in lower cash payments related to PRB reserve installments, $75 million in lower cash payments related to health benefit trust payments, and lower currency and fuel hedge losses as legacy hedge transactions roll off. Peabody has reduced its currency hedge program, and the table below displays the declining hedge positions over time using forward diesel fuel prices and exchange rates as of June 30, 2015.