Peabody Energy $BTU Anglo American Australian Acquisition Update

Coal, the new whale oil

Merry Christmas to all, and to all a good morning!

I would like to take a brief moment and say thank you to everyone who has retweeted or restacked any of my writeups. It has been quite a journey since May 26th when I wrote my first article. I’m about 25% toward my goal of having 2,000 people who think that this substack is worth $5 a month.

I have fielded a few phone calls from subscribers who had additional questions about some of my writeups, and they have asked for some way to compensate me for my time above and beyond the subscription, so I have created a digital tip jar. Eventually I would prefer to create some sort of a merchandise store so that people can buy trophies of past winners. There’s something undignified about tip jars, but there’s something very Dexter about collecting trophies. Would there be any interest in buying a laser engraved Tom Selleck paperweight if Finance of America goes past $100 a share?

In the meantime, here is a link to my digital tip jar. And this is not meant to be a Christmas shakedown.

buymeacoffee.com/unemployedvaluedegen

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And now for the actual discussion about Peabody Energy (BTU), for reference, here is a link to my original writeup:

On November 25th Peabody Energy (BTU) announced that they were acquiring four hard coking metallurgical coal mines in Australia from Anglo American (NGLOY) for $1.695 billion in cash now, another $625 million in cash later, and potentially up to $1 billion in cash over five years if and only if metallurgical coal prices are over $240.

The stock price was down on the news of the transaction, and it continued selling down with the nearly unprecedented 14-day selloff in value stocks afterward. Today, BTU’s share price sits at an embarrassingly low $20.05 despite yours truly putting out a trade alert to buy it at $23.85 as it reached key technical supports on November 29th. Clearly that was a mistake in hindsight, but not a lot of people anticipated the aggressive selloff and rotation into the Magnificent Seven for the first two weeks of December. That will always be the flaw in technicals, but it’s still better to look at them than to not. And if its worth any consolation, I have invested alongside every trade alert. I don’t buy every stock I write about, but I do buy every trade alert.

At first instinct, this should be a cheap purchase price. Coal prices are down at the moment, Anglo wants to divest of dirty, shameful, evil, planet-boiling coal to fetch a higher multiple, and the Grosvenor mine recently caught on fire and is not currently operating. That should imply a deep value discount so that Peabody shareholders can make a lot of money as the new tobacco. But the market hated this acquisition, mostly because it means less immediate cash to be spent toward share buybacks. Interestingly, Peabody has already bought back a reasonable amount of shares from 144 million in June of 2022 to 121 million today. During this time, the market capitalization is down from $4.5 billion to $2.5 billion. The share price is down from $31 to $20, meanwhile the price to book ratio has fallen from 1.3x to 0.66x over this period. What an absolute nightmare of multiple compression despite shrinking the float by 16%.

Peabody haters say that while they allocated a lot of money to share buybacks, they didn’t spend it fast enough. Well, is the purpose of share buybacks to retire shares, or to temporarily pump and dump the price? Another common reason given for why shares of Peabody are so low is the money that is sequestered by regulators for land remediation. But I’m not so certain this argument holds much water, Peabody is cheaper than peers not just on price to book, but also on price to earnings, with a trailing twelve month P/E ratio of 5.31x compared to Consul Energy’s (CEIX) 7.66x, Warrior Met Coal’s (HCC) 7.50x, Arch Resources’ (ARCH) 14.51x, and Ramaco Resources’ (METC) 14.75x. CEIX’s share buybacks are only for 14% of float over this same period, and it looks like ARCH had a lot of convertible debt to retire, and has not yet started focusing aggressively on buybacks. METC and HCC are spending on development capex instead of share buybacks.

Looking at the acquisition itself, there was a fire recently at the Grosvenor mine, and who knows when or if that will come back into production. But the other three mines represent 11.3 million short tons of metallic coal production for 2026. Also, by 2026, the construction of the Centurion mine should be finished, and that would add another 4.7 million short tons of met coal for 2026, adding to Peabody’s 2024 prior annual production of 7.4 million tons. On that prior production, seaborne metallurgical coal generated $448 million of EBITDA in 2023. With 2026 production at 21.9 million short tons, that would be $1.325 billion of EBITDA from metallurgical coal at 2023 prices, about $295 per short ton. Current hard coking coal prices are lower, but for coal enthusiasts, demand is a story of growth in the Indian economy.

So is it smart to buy 11.3 million short tons of metallurgical coal production for $2.32 billion, mostly funded with a $2.075 billion bridge loan, soon to be refinanced? Putting a valuation on Peabody to determine if the acquisition was accretive is difficult. What is the value to place on 2023 $952 million of thermal coal EBITDA as compared to 2026 11.3 million short tons of Australian hard coking coal? Coal enthusiasts have strong opinions about metallurgical over thermal. But Peabody trailing 12 month EBITDA is $1.1 billion, and on November 22nd, before the announcement, market capitalization was $3.42 billion. Enterprise Value is lower than Market Capitalization due to the sequestered cash horde, so for conservatism’s sake, I will use the larger number. That’s a 3.1x trailing twelve month EBITDA multiple. At a $225 met coal price, the acquisition was done at exactly the same 3.1x EBTIDA multiple. So in this case, just by the cashflow, it’s a total wash whether Peabody would have been better off spending the money on share buybacks or the acquisition.

But beyond the numbers, metallurgical coal companies are valued at a higher multiple than thermal coal companies. This makes sense if people believed that the future of thermal coal were shorter than metallurgical coal, not a terrible assumption. If I were an activist investor and could force a spinoff of the two business segments in 2027 after some debt repayment, a pure metallurgical coal company could easily trade at a much higher multiple than Peabody does today. If the market comes to think of Peabody as a primarily metallurgical coal company, it might achieve a multiple rerating, compared to current peers, at least an extra 1x. So taking 3.1x EBITDA of a mostly thermal coal company to buy at 3.1x an entirely metallurgical coal asset is probably accretive, even if shareholders hate it for the moment.

On the other hand, this makes Peabody a primarily Australian company, and Australia has been pernicious with raising royalty rates. The government is left-leaning, environmentalist, and unlike many democracies today, does not show clear signs of being overthrown by the reactionary alt-right, as they are portrayed in the legacy media.

And while I am discussing Peabody, I have to engage in a little catharsis and criticism. In their investor presentation, they claim to return to shareholders at least 65% of free cash flow. But looking at their performance for the last four years shows a very different allocation. Even if we look past the $725 million that was forced to be allocated to reclamation funding by our very own pernicious regulators in the US, that still leaves only 24% of cash flow going toward dividends and share buybacks. With this recent acquisition, especially with the intention of issuing convertible debt, not only the debt reduction but even the share buybacks can be undone by management.

So at the end of the day, we have professional managers growing their empire, engaging in insider selling, nary a capitalist among them to guide a true policy of returning capital to shareholders. But, you also have a $2.41 billion market capitalization company that could easily have over $2 billion of EBITDA in 2026. So how bad does management have to be to not want to buy something at pretty close to a 2026 price to EBITDA ratio of 1x? If it really is true that in the short run the market is a voting machine, but in the long run it is a weighting machine, this is an awfully heavy company for $2.41 billion.

If you are buying Peabody Energy for the eventual multiple rerating, this acquisition kicked that rerating off by a year at least, probably two. But when it does eventually rerate, there is a lot more company to revalue. The only reason to pass on Peabody Energy is if you believe that there will always be another acquisition to push the rerating farther and farther out into the future. Unfortunately that might be true. But it is also possible that once all the mining conglomerates have divested of their coal assets, there are no more bargains to be had, and Peabody might be unable to find anything to buy for long enough for the market to forget. Also, even with the current payout policy, 25% of $2 billion 2026 EBITDA would still be dividends and share buybacks of up to $500 million in 2026 on a $2.41 billion market capitalization. On top of that, it might be a prudent idea to buy Peabody just because we are potentially at a trough in coal prices with China stimulating and India growing at 7%, we might be off to the races once again. The bigger the base the bigger the breakout, as they say, and Peabody has been trading sideways in a tight channel for almost three years despite more than doubling tangible book value per share.

In the meantime, if you don’t want to buy and hold Peabody, even though this is an excellent entry price, you can try to play along with the magical money machine that is selling Peabody at the upper Bollinger Band, and buying it back at the lower Bollinger Band. This strategy has worked very well for the last couple of years, and could easily continue to work. I announced to readers that I had exited Peabody at over $29 around November 11th, as the price was outside of the upper Bollinger band. I have since bought back in, although a bit prematurely, and I am out of dry powder to buy anymore at the current price.

Peabody Energy has a lot of similarities to Vermilion Energy (VET), which I wrote about on the 24th of December. The market hates management and every decision they make, the multiples have compressed for the last two years, but the companies just get heavier and heavier. In terms of the accretiveness of the transaction, that will depend on future coal prices versus future natural gas prices, but at the moment it looks like Vermilion Energy did the better acquisition. By Peabody explicitly stating that they would use a portion of convertible debt to fund the acquisition, undoing past buybacks, and relying on the multiple rerating to metallurgical, which may prove elusive in the near term, it is easier to hate the Peabody acquisition. But that hate might be proven wrong eventually. Peabody and Vermillion have almost identical trailing twelve month EBTIDA’s, but Vermillion is almost half the market capitalization, and both oil and especially natural gas are projected to have a longer future than coal. While Peabody could easily double, Vermilion could be a four bagger in the same environment.