Peabody vs Whitehaven

Jan 28, 2024

I received the following question earlier this week and it spawned some thoughts on both companies which I thought I’d share. Since so many subscribers get access to me in various ways (Twitter, Discord, Substack, Email, etc.) I probably need to do more articles like this just to get my thoughts across to the broader audience. Anyway, here’s the question:

Do you think Peabody or Whitehaven is the better value here over a couple years timeframe? Or is that overthinking it?

Whitehaven

The BMA acquisition is expected to be completed on April 2, 2024. I continue to believe this acquisition will prove to be a transformational pivot for Whitehaven long term. The long-term fundamentals for metallurgical coal are much more bullish compared to thermal and I would not really be interested at all in Whitehaven if they had not made this acquisition. I expect the seaborne thermal markets to perform poorly from here and even trend lower towards the marginal supplier costs as we move past this winter and into the next shoulder season.

I expect high quality thermal producers like Whitehaven (and Peabody) to stay well within the positive profitability range for their thermal segments. Nevertheless, peak cycle cash flows for thermal are behind us and a focus on met going forward is the correct path. Both Whitehaven and Peabody are pivoting in that direction, and both will have a good mix of both met and thermal once the BMA acquisition is complete, so the comparison of the two is appropriate.

Whitehaven has, and will continue to have, a robust balance sheet despite the BMA acquisition. Everyone complaining about the lack of buybacks in lieu of this acquisition is being extremely short sighted. The met pivot will basically double Whitehaven’s historical cash flows and eventually allow a materially larger buyback over the next few years. The BMA investment of $2.1 billion will likely return +30% IRR’s as long as nothing changes in terms of the supply vs demand backdrop for met coal. IRR’s of that magnitude are far superior to buybacks, and the buybacks are likely to resume in the next year or two anyway.

The $2.1 billion owed in early April, on top of the $100 million already paid as a deposit, will be sourced from a $1.1 billion debt facility, with the remaining $1.0 billion paid from cash.

Whitehaven has the option of doing a sell down on BMA from here. So far, they are only discussing this in terms of Blackwater, with a target sell down of 20% (and a noted potential maximum of 30%), see here. Daunia has likely been excluded due to the synergies with Winchester South. A 20% sell down would likely be worth close to $800 million, paying back a significant chunk of Whitehaven’s cash outlay. This just shows you how much these assets are really worth in the real world with no constraints. The sell down option also materially de-risks any sort of liquidity worries in the near term, so it would be wildly bullish, in my opinion.

I maintain the view that Whitehaven will likely double 12 months out from this acquisition. They were priced at A$6.79/sh pre-announce and they’re at A$8.14/sh today. That’s only a 20% move, so you still have time to load up.

Peabody

Similar to Whitehaven, Peabody’s management seems to have a renewed focus on met coal, having decided to give Shoal Creek another try, as well as recommencing North Goonyella (renamed Centurion). To give the Centurion investment a larger return and extend its mine life by 20 years, Peabody also acquired the adjacent coal deposit known as Wards Well from Stanmore Resources for $109 million, see here. Since starting re-development of Centurion in late 2022, Peabody has spent $75 million. As of early Q4 2023, Peabody believed to have a remaining capex of $489 million in order to bring the mine to full production.

Keep in mind, Centurion produces a very high-quality coking coal. It’s a premium medium-volatile, high CSR hard coking coal that should capture most of the PLV HCC premium in the market. It’s very rare to see incremental tons of a premium caliber coking coal like this come into the market. In 2017, the last full year this mine operated, Peabody produced 2.9 million short tons. If they can put Centurion back into that range of productivity, it’ll be very meaningful to the bottom line, on an order of magnitude of say $400-500 million per year in gross profits, depending on costs. Longwall production is expected sometime in early 2026, but development tons will arrive before that.

Shoal Creek appears to be ahead of schedule, according to MSHA data at least (see here, or here). In 2018, the last year before Drummond sold Shoal Creek to Peabody (see here), they managed to produce over 2.5 million tons, refer below:

While that figure may not be doable in 2024, I don’t see any reason why 2 mstpy should not be the appropriate long-run target for Shoal Creek. In 2024, Peabody shareholders would/should be very satisfied with a production figure of around 1.5 mst. Conservatively, I think Shoal Creek’s profit margins could be close to $85/t, which would be approx. $128 million in gross profits. But we’ll have to see what sort of guidance they provide in the next couple of weeks to get a better feel for Shoal Creek’s profitability.

The rest of Peabody’s met portfolio looks fine, except for the poor relativities which is not in their control. And for the comparative purpose of this article, Whitehaven’s Blackwater and Daunia mines also have to deal with the poor relativities in the market.

The fundamental flaw with Peabody’s investment thesis is their US thermal assets, including their Powder River Basin operations. My outlook for each segment in Peabody’s portfolio, in terms of profit margins, is as follows:

Met Segment: $84/ton in early 2024 to $70/ton in late 2025 (higher once Centurion commences in 2026)
Other US Segment: $8/ton in early 2024 to less than $1/ton in late 2025
PRB Segment: $2/ton in early 2024 to $0/ton, or less, in late 2025
Seaborne Thermal Segment: $20/ton in early 2024 to $14/ton in late 2025

As you can see from the profitability outlook in each of the segments above, Peabody is going to have to address their US thermal operations in some form or fashion over the next few years. I’m of the opinion they should be prepared to walk away from the PRB, and also be prepared to shut down any unprofitable mines while US thermal demand continues shrinking over the next few years. I think this strategy could even unlock extra FCF in the form of SGA expenses associated with those segments.

However, I’ve been informed by colleagues who have spoken to Peabody management recently, that they’re not running away from the PRB even if others are doing so. This is not ideal from the shareholder standpoint, and I think this is the key differentiator between Whitehaven and Peabody, MANAGEMENT.

Conclusions

To sum this up, I think both Whitehaven and Peabody have much higher share prices in their future. Both companies are pivoting more towards met coal and I think the valuation uplift from each of these investments will drive future share appreciation. Whitehaven gets the edge here due to the magnitude of their met pivot/investment, $2.1 billion, and the leverage inherent in their deal structure. Peabody’s met investments will probably have higher IRR’s, as long as they execute, but the overall magnitude of these investments is smaller in scale compared to the BMA acquisitions.

Where Whitehaven really begins to separate itself from Peabody is management. Paul Flynn has done a great job navigating Whitehaven throughout this cycle and he’s proven to have a long-term shareholder value driven perspective, choosing to acquire BMA mines as opposed to continuing the buyback.

Peabody, on the other hand, hasn’t really made any own goals recently, but we’re all just waiting for the next misstep. This is unfortunately how coal sector investors perceive the current crop of Peabody leadership. To make matters worse, Peabody is probably destined to have some hard decisions over the next few years with regards to their US thermal operations. I expect US thermal demand to decline precipitously in the years to come and this management team will be put to the test. So far, they’re still sending all the wrong signals to the market.

In conclusion, I think Whitehaven is a better value here with a 2-3 year timeframe. Both have risks associated with their thermal assets, but Peabody’s risks will be far more acute. Moreover, I trust Whitehaven’s management over Peabody’s in terms of mitigating risks in their business going forward.

Addendum

After sleeping on this article and re-reading it this morning, I noticed that I didn’t even mention Elliott once. So here’s the one caveat to everything I said above:

The Elliott exit should be more or less complete by the end of Q1 2024. This will increase the impact of Peabody’s buyback by about 1 million shares per week. So from a trading catalyst perspective, there is a reason to be overweight Peabody instead of Whitehaven at the moment. This is probably on a short to medium term perspective, say 3-6 months. Moving beyond that timeframe, after Whitehaven closes on BMA in April, the short term trading catalyst will then be back in Whitehaven’s court due to the potential positive news on the Blackwater sell down.

With that being said, I feel better that I’ve covered all the angles here! Thanks for reading!

Please let me know if you have any questions with regards to strategy and positioning, or anything coal related. I try to answer every question.

The Coal Trader

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