Peabody Energy Corp

NYSE:BTU

Earnings Call Transcript 2020-Q2

[Operator]

Good morning, ladies and gentlemen and welcome to the Peabody Energy Q2 2020 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded today August 5. I would now like to turn the conference over to Julie Gates. Please go ahead, ma’am.

[Julie Gates, Investor Relations]

Thank you. Good morning, and thanks everyone for joining Peabody's earnings call for the second quarter 2020. With me today are President and CEO, Glenn Kellow; and CFO, Mark Spurbeck. Within the earnings release, you'll find our statement on forward-looking information as well as a reconciliation of non-GAAP measures. We encourage you to consider the risk factors referenced there, along with our public filings with the SEC.

I'd like to now turn the call over to Glenn.

[Glenn Kellow, President and Chief Executive Officer]

Thanks, Julie, and good morning, everyone. First and foremost, I'd like to thank our employees for their continued dedication to providing essential products that are vital to so many in these uncertain times. As always, the health and safety of our employees is paramount to everything we do. We continue to operate under robust protocols and procedures in line with the CDC and other health department guidelines to help mitigate against COVID. Obviously, COVID has had a significant impact across the global economy. Specific to coal supply and demand impacts are key to understanding the backdrop in which we are currently operating.

So today, I'd like to start with an overview of current market conditions and then move into actions we have taken to reposition our cost structure. I'll then provide an update on key initiatives before turning the call over to Mark to cover the financials. While the global economy continues to navigate through the pandemic, the timing, scope and scale of the recovery remains uncertain. Idled steel capacity across Europe and the Asia Pacific has greatly impacted metallurgical coal demand. Year-to-date through June, global steel production was down 6%, excluding China global steel production was down 14%. As a result, demand for major met coal importing countries, excluding China has been down year-to-date. While we have seen some supply responses prolonged uncertainty has resulted in continued pressure on seaborne metallurgical pricing.

Highlighting how uncertain this market is. China was a net importer of steel for the first time in 11 years in June. And that was even with the record daily crude steel production during the month. On the thermal side, week overall electricity generation and competition for both natural gas and LNG has resolved in challenging fundamentals as well. Furthermore, slower economic activity continues to rely on large importing nations in particular, India’s thermal coal imports are down 20 million tons from the prior year through June.

While Chinese thermal coal imports were up earlier this year, uncertainty around the imposition of import restrictions have begun to impact demand. Many thermal coal imports from China was down 20% year-over-year. Even though we've seen some supply responses, seaborne thermal coal process remain depressed.

Indonesia exports are down 17 million tons through June and U.S. exports down 7 million tons through May. In addition, we'd expect further supply cuts as most major seaborne suppliers have revised guidance lower. In the U.S. COVID disruptions have been coupled with extremely weak natural gas prices and growth in renewable generation, further pressuring coal demand and potentially accelerating the secular demand decline already underway. Through June, total load was down 4%, while coal generation fell 31% to just 17% of the generation mix. Natural gas and wind both took share rising to 39% and 9% of the generation mix respectively. Preliminary data for July indicates improved coal generation. And just recently we've seen an uptick in natural gas prices, that if that holds, should provide a more fibro backdrop for coal and should the railroads be able to flex up to the increased demand.

Notwithstanding this, the overall weak demand couple was depressed pricing has required us to continue to aggressively pursue our cost repositioning program. To date, we've made significant progress and we have needed to, yet still more needs to be done. We have temporarily auto production at some lines, adjusted shift schedules, scale backed our workforce and reduced the number of units in operation.

I’ll go into a bit of a detail. From a workforce perspective, we've eliminated an additional 450 positions since April. Entitled since the beginning of the year, we've scaled back our level workforce by 15%, as we continue to adapt to dynamic conditions. Over the past 18 months, our global head count has declined by 24% due to a combination of actions taken, as well as natural attrition. When possible, we furloughed works, allowing to retain and benefits while we adjust to lower demand profiles. Most notably in mid June, we furloughed about 280 employees and contractors that are run by Underground Mine.

We have restructured the Coppabella and Moorvale mines to operate as a single mining complex. We have popped three production units, which includes trucks, traders, dozers and supporting equipment. And as a result, we've also scaled back our workforce by about 15% from the complex. We'd expect these structural changes to result in increased efficiencies moving forward. In part to these benefits, 10 out of 17 currently owned and operated mines have demonstrated cost per ton improvements when comparing second quarter actual results to the financial year 2019 performance. And that's even with substantially lower volumes.

These improvements are most notable across our surface operations. They quickly responded to and overcame rapidly declining demand. Cost per ton in our surface operations improved 6% compared to the prior year even as volumes dropped nearly 30%. Our Underground room and pillar operations have also responded well to challenging conditions. Our longwall operations, however, have not been able to respond as quickly to lower demand. As you could imagine, spin down production in the long wall operation is a bit more difficult given complexities with fixed costs and often the geotechnical desire to advance the wall.

While we have made significant progress, we know we cannot stop here. We will continue to pursue aggressive actions, particularly at our longwall operations to improve our cost performance across the entire platform. We also continue to advance several commercial processes, including the pending PRB/Colorado joint venture with Arch and options for North Goonyella. Closing arguments in the joint venture hearing will be held next week. While we always believed in the benefits of the joint venture would bring to multiple stakeholders, the cases only grown stronger in 2020. Challenging demand conditions have underscored the need for this transaction to remain competitive with other fuel sources. We look forward to the judge’s ruling by the end of the third quarter.

We also recently concluded the first round of the North Goonyella commercial process in which we continue to have interest for multiple counterparties. The second round is underway and we look forward to providing an update at the appropriate time. We will continue to weigh these options against strategic development alternatives, market conditions, and the status of the commercial process have continually monitored to determine the timing of any incremental spend related to ventilation and re-entry of zone B.

With that, I’ll now turn things over to Mark in his first official call as Chief Financial Officer to cover the quarterly results.

[Mark Spurbeck, Chief Financial Officer]

Thanks, Glenn, and good morning, everyone. I’ll start today by walking through a few in notable items in the financials. Second quarter revenues declined 45% from the prior year to $627 million and significantly lower volumes in depressed pricing. Both seaborne demand and pricing were impacted by the ongoing COVID-19 pandemic. U.S. thermal volumes and prices were negatively impacted by continued weakness in natural gas prices. In addition, the closure of Kayenta in 2019 contributed to lower year-over-year revenues and volumes.

Second quarter results include a $1.4 billion impairment charge at our North Antelope Rochelle Mine, despite it being a fabulous asset. Lower long-term, natural gas prices changes in timing of coal plant retirements and continued growth in renewable generation led us to change our long-term life of mine assumptions, resulting in the impairment charge. While we still believe coal is essential to reliable energy grid and that our PRB assets are best positioned to serve that demand as witnessed by our 19% Q2 margins of the PRB. We do expect coal is the long-term share of the U.S. generation mix to remain below prior year levels. Competition from other fuel sources, particularly natural gas and wind remains fierce.

Underscoring the case for the PRB/Colorado joint venture with Arch, as litigation continued during the quarter, we incurred $13 million in transaction costs for the proposed joint venture. As Glenn mentioned, we’ve taken a number of actions across the business to improve our cost structure, resulting in restructuring charges of $16.5 million in the quarter. Some of the benefits from those actions are seen in the reduction in SG&A by 35% from the prior year. Year-to-date, SG&A expense of $50 million reflects the lowest level for comparable periods since 2003.

Turning now to segment results. Let’s begin with seaborne thermal. We sold 4.6 million tons with 2.5 million tons exported. Year-to-date, export sales have totaled just over $5 million tons and the average price of $56 per short ton, largely in line with the average new castle benchmark price over the same period. The seaborne thermal segment responded well during the extremely weak pricing environment by delivering cost per ton of sub $30 leading to 17% adjusted EBITDA margins. Shipments from our seaborne metallurgical operations were nearly half than the prior year levels, as COVID disrupted global demand and we continue to be challenged by production constraints.

Lower volumes, particularly at Shoal Creek, Coppabella and Moorvale contributed to significantly higher cost per ton of $121 for the segment. In addition, on payroll accounting impacts related to net realizable value adjustments increased net costs. Albeit slower than anticipated, we are continuing to progress the mainline conveyor system upgrade at Shoal Creek. We’ve also experienced lower yields at the mine further impacting coal availability.

During the quarter, Coppabella experienced the planned dragline outage on time and budget, which also impacted costs. Cost at Moorvale improved significantly in June following elevated overburdened ratios earlier in the year. Given Moorvale’s geology, there are times in which we will be primarily removing overburden as we were for parts of the first half of 2020. We expect to remain on coal for the remainder of the year.

Our U.S. thermal assets responded extremely well, to rapidly declining demand, reporting average adjusted EBITDA margins of 20%. In the PRB, coal shipments declined 28% compared to the prior year, primarily due to continued low natural gas prices impacting demand. Regardless costs improved 5% to $9.26 per ton, compared to the first quarter cost per ton came down $1.02, as we realized the benefit of set room regained in the first quarter and continue to reduce repair and maintenance expense, increased productivity, optimized blending of in-pit inventory, and began to realize benefits of headcount reductions taken earlier in the quarter.

These cost improvements contributed to the PRB segment, earning 19% adjusted EBITDA margins in the quarter. To put the PRB volume decline in perspective, year-to-date, we have shifted an annual pace of 83 million tons compared to 2019 sales of 108 million tons. Yet we quickly scaled down operations to meet lower customer demand, all while delivering lower cost per ton. The other U.S. thermal segment also responded well to challenging industry conditions, leading the company and adjusted EBITDA margins at 22%, despite volume declines cost per ton remained in line with the prior year, as the team further streamlined its operations by reducing spending on materials, services, repairs, and labor among other items.

Let’s turn now to the balance sheet and cash flow. We ended the quarter with $849 million of cash and $926 million of liquidity, which marks a $262 million reduction from March 31. During the quarter, $48 million of cash was used for operating activities, including about $25 million of net interest payments and $15 million of an ARO cash spend. An additional $79 million was used for investing activities, including $55 million for capital expenditures. In addition to cash usage for operational needs, availability under the accounts receivable securitization facility declined, and we posted additional collateral for certain long-term obligations.

To enhance our financial flexibility, we are undertaking a process to evaluate various strategic financing alternatives, including a debt for debt exchange among other options. In line with this, we’ve designated our Wilpinjong mine and the related legal entities as unrestricted subsidiaries in accordance with the negotiated terms of our senior notes and credit agreement. Year-to-date, Wilpinjong has accounted for 74% of total seaborne thermal segment adjusted EBITDA. Given this process is ongoing, we will withhold further comment and refrain from answering questions on this topic today.

Given continued uncertainty in global markets, we are continuing the suspension of full year 2020 guidance. Consistent with last quarter, there are a few known factors I’d like to discuss. Cash preservation remains key, and something we are focused on across the business. We further reduced the full year 2020 SG&A by $10 million to an estimated $110 million. We’ve also cut capital expenditures by another $35 million to $200 million and deferred $10 million of ARO cash spend in future periods based on operational sequencing. Peabody has an outstanding reclamation track record and remains committed to restoring the land in a timely manner, and in full compliance with regulatory requirements.

Shifting to contracted sales, while sales volumes were ultimately be dependent upon general economic conditions, weather, natural gas prices and other factors, as we sit here today, we expect PRB volumes in the second half of the year to increase relative to the first half of the year. We have 46 million tons committed for second half delivery versus first half shipments of 41 million tons. Other U.S. thermal shipments are expected to largely be in line with the first half of the year. We also have 2.1 million tons of export seaborne thermal sales already priced for the remainder of the year. As a reminder, we also sell export volumes on a spot basis.

Moving forward, we believe it’s necessary to take further actions to strengthen our cash flows. Across the business, we are focused on driving improvements to counter the impacts of lower demand and pricing and better position the company for the future.

I’d now like to turn the call over for questions. Operator?

[Operator]

Thank you sir. [Operator Instructions] Mr. Mark Levin from Benchmark Company, please ask your question.

[Mark Levin, Benchmark Company]

Okay. Thanks very much. A couple of quick questions, I’m trying to stay away from guidance. Because I know you guys have suspended it, but maybe some thoughts on how to think about net coal volumes and cost in the back half of the year, to the extent you’re able to comment.

[Julie Gates, Investor Relations]

Yes. Mark, this is Julie. So obviously, you’re right. We’ve suspended guidance there. It’s largely going to be a factor of what demand is, right? And what we’ve seen here recently has been met coal demand fall off quite a bit more. Steel production, year-to-date through June was down 14% excluding China. So that’s a pretty drastic move. We’re continuing to work with our customers and we’ll continue to work with them to meet their demands. But it’s really just a pretty big unknown at this point.

[Glenn Kellow, President and Chief Executive Officer]

And in remarks, I’d mentioned the focus on the longwalls operations, two of our three longwalls are mid-assets. And as I said, we’ve been particularly focused on the fixed costs associated with those mines with reduced demand levels. So that continues to be a focus of our ongoing program.

[Mark Levin, Benchmark Company]

Yes, got it, absolutely. It sounds like there was a lot going on in the second quarter that might be one-time. I know you guys had talked in the past about getting to kind of a $95 cost number. It doesn’t look like that that would happen this year, but I’m just curious, if there’s the potential to get costs below $100 million at some point in the back half of the year.

[Glenn Kellow, President and Chief Executive Officer]

Well, certainly, I would see, either time, we want to target that level. But that would assume that we’d be operating at capacity or normal rights. And as Julie said, that’s going to be dependent upon talking to our customers, working with our capitalism. What the – their end situation is in the second half of the year. So we’re not really able to predict that at this point.

[Operator]

Mr. Lucas Pipes from B. Riley FBR, please go ahead with your question.

[Lucas Pipes, B. Riley FBR]

Thank you. Good morning. I wanted to [Technical Difficult] recorded already indicated that kind of customer interests starting to refer, what is going to your comments on that? Are you seeing increase inbounds for the economies over for still executed especially kind of [Technical Difficult]

[Glenn Kellow, President and Chief Executive Officer]

Yes, I understand the question. Because we didn’t call it here, but I think the question you’re asking, you’re hearing other folks potentially both talking about customers building a little bit optimistic about the second half. Is that the sort of general nature of the question?

[Lucas Pipes, B. Riley FBR]

[Technical Difficult]

[Glenn Kellow, President and Chief Executive Officer]

Yes. I think for us clearly China importing steel is probably a general positive. But we do have lockdown securing and idle capacity occurring across much of our target customer markets. We are starting to have the same sorts of conversations you’ll hearing. But I think it’s too early to sort of call that. I think it’s still a lot of uncertainty in the market, and clearly, tough conditions out there for foreseeable in metallurgical coal. And that probably is reflected in why, it’s been range bound. But also I’d probably indicate that a lot of unknowns around China and the import restrictions on met coal or coals going into China as well. And how quickly those targets are going to be held and would they be relaxed in some way in the second half of this year. So still a lot of uncertainties, as the pitch we’re trying to pipe.

[Lucas Pipes, B. Riley FBR]

Okay. I appreciate that. And then I wanted to follow-up on Mark’s question regarding principal cost. I hear it or see it anywhere in regards to that, the number on lower accounts for the lower value kind of cost per return [Technical Difficult]

[Mark Spurbeck, Chief Financial Officer]

Yes, Lucas, thanks for the question. We had net realizable value adjustments pretty much across to our met portfolio. Round numbers, it’s probably about a $20 million or $20 a ton impact.

[Julie Gates, Investor Relations]

Now with that being said, it’s a non-cash adjustment, I’d just point out. And then when that coal is essentially sold, it would be reverses that essentially. So it’s just an accounting adjustment, but it did have a sizable impact on our cost performance. No doubt about it. Certainly underscoring what tough market conditions we’re in, given it’s based off of stock pricing as of the end of the quarter.

[Operator]

Mr. Matthew Fields from Bank of America, please go ahead with your question.

[Matthew Fields, Bank of America]

[Technical Difficult] What’s your plan for any exchanges, but just wondering how you accomplished the designation within the confines of the [Technical Difficult] indenture? Did that come in through the permitted 150 per year of RP [Technical Difficult] about that you were able to read the [Technical Difficult]

[Mark Spurbeck, Chief Financial Officer]

Matt, it’s Mark. I heard most of your question. We’re having some trouble with the line. But what I would say is, that we effectively designated Wilpinjong mine is an unrestricted subsidiary in accordance with the negotiated terms. So the senior notes indenture and credit agreement, we don’t discuss and disclose individual baskets. But I will reiterate that everything we’ve done is consistent with the negotiated terms of the documents.

[Matthew Fields, Bank of America]

All right. And then can you talk about all the expenses in prepared remarks, you have additional collateralization. By my math, you should have had about $125 million more [indiscernible] additional cash collateral you were forced to post in this quarter.

[Mark Spurbeck, Chief Financial Officer]

So we had about $80 million of collateral that was posted during the second quarter. Was there something additional for that.

[Operator]

One moment, please. Mr. Fields, please go ahead.

[Matthew Fields, Bank of America]

Yes. Okay. Thank you. And then do you anticipate having to post any more collateral going forward throughout the year?

[Mark Spurbeck, Chief Financial Officer]

We routinely have negotiations and discussions with our surety providers. Early in the third quarter, there was about $50 million that we have posted here in July. We don’t anticipate a significant more at present time. However, we have those negotiations and the sureties have the right, contractual right to request additional collateral up to a 100% of the surety bond amount.

[Julie Gates, Investor Relations]

And Matt, I think you're aware, but those are generally in the form of letters of credit, not cash collateral postings.

[Operator]

Mr. David Gagliano from BMO Capital Markets, please go ahead with your question.

[David Gagliano, BMO Capital Markets]

I hope you can hear me. I just have a question regarding the changes to the designation of the subsidiaries at Wilpinjong. Does that mean potentially divesting that asset is also under consideration?

[Mark Spurbeck, Chief Financial Officer]

No, I'll say that the designation of a restricted or unrestricted subsidiary has no implications of whether or not that asset would be for sale. We have no current plans today to have that asset for sale.

[David Gagliano, BMO Capital Markets]

Okay. Thanks. And then in terms of the NII deposit, I think I missed the answer here. But I met coal cash cost in the second quarter. Was it just mentioned that there was a $20 negative headwind in the second quarter and does that go away all else equal cash costs should be down $20 a ton in the third quarter in that?

[Mark Spurbeck, Chief Financial Officer]

The question was, what was the impact of the net realizable value adjustments to inventory that we recorded during the second quarter that impact is approximately $20 million per time per ton – $20 per ton I said that twice now, $20 per ton in the second quarter. The non-cash charge, effectively, the inventory that we have on the books is valued at the realizable price less than it costs to get it to market.

[Julie Gates, Investor Relations]

And so just a little bit bucks for color there. That is based on a time sold, right, which were down substantially, so that we only sold about a million bucks per ton or a million tons. Now I'm getting – doing the thing million tons in the quarter versus 2 million ton in the prior quarter. So $20 million impact roughly, but on a per ton basis, it was outside given the weak demand that we saw in the quarter.

[Glenn Kellow, President and Chief Executive Officer]

And going forward just to reiterate, it's going to be a function of demand or sales that we take in the second half of the year. And also in particular, I keep going back to well longwall operations, their ability to continue to respond to changes in demand profile.

[Operator]

Mr. Matt Vittorioso from Jefferies, please go ahead with your question.

[Matt Vittorioso, Jefferies]

Yes. Thanks for the question. Could you discuss the – I don’t know if there is any covenant issues with your credit facility and clearly, you've got a bunch of cash, but you're using the credit facility to post collateral and some of those other liabilities. So other maintenance covenants or, or any other covenants issues that are coming down the pipeline on that facility?

[Mark Spurbeck, Chief Financial Officer]

Matt, yes, one I'll just reiterate or confirm, we are in compliance with all the covenants in our debt documents. The covenant that is probably what you're referring to is the net leverage ratio of two times. And as we progress through the back half of the year here that firstly net leverage ratio will start to get tight. We are going to do whatever it takes to maintain compliance and access to the revolving credit facility.

[Matt Vittorioso, Jefferies]

Okay. And then I guess I'll just make more of a statement than a question. I mean, you guys spent a bunch of money on buying back equity while back and no one knew what conditions were going to look like in 2020, but not to the extent that your lenders are getting on this call, asking you legitimate questions about how you're maneuvering assets and what you're going to do with your cash. And I think a little bit more transparency would be appreciated just given that, we didn't need to be in this tight spot. So maybe just consider that. Thanks.

[Mark Spurbeck, Chief Financial Officer]

Thanks, Matt. I'll just – as I mentioned before, we won't discuss any specific plans today, but as I mentioned in my remarks, a debt for debt exchange is one of many financing options that we are considering.

[Julie Gates, Investor Relations]

Matt, and I think it's important also to recognize that the market landscape has changed considerably and drastically within just the last six months of the year. I mean, even if we just look at net prices in Q2 versus – of 2019 versus Q2 of 2020, I mean, we were talking about over $200 of tons versus $118. And so if you think about the backdrop of when we were making those decisions versus where we sit here today, things have drastically changed and nobody could have known that. And then COVID has obviously, add it to that uncertainty as well. So we're taking multiple steps across all areas of the business. Glenn, talked quite a bit today about the cost repositioning program. We've taken drastic actions on that front as well. I mean, over the past 18 months, we've eliminated 24% of our head count. So we're taking actions throughout the business and tackling it from every way that we can. No doubt about it. Preservation remains key here, but we believe we're doing what we need to do.

[Operator]

Mr. Scott here from Clarksons. Please go ahead with your question.

[Scott Schier, Clarksons]

Hi, good morning, everyone. If I could also follow up on some of the questions about net coal costs. Some of the reasons you decided for the elevated costs in the quarter, other than the lower volume impact to their system upgrade took sequencing in the plant drive. On average, are all of these situations kind of behind you at this point or more some of these impacts per system of the third quarter?

[Glenn Kellow, President and Chief Executive Officer]

Yes. So the dragline outage at Coppabella scheduled outage was done on time on budget. At Moorvale because of pit sequencing, we expect to be on call in the second half of the year. So I guess, entering the year we knew the first couple of quarters we're going to have those factors. The conveyor upgrade is taking a little bit longer at Shoal Creek than we envisage. But we would expect to conclude that in the second half of the year. I think ultimately costs are going to be more of a factor of volume. That's moved and our ability to respond particularly with fixed costs. We've taken steps across really the entire platform. But if I single last say metropolitan, one of my underground mines longwell operations, we have looked to supply that advance and take out fixed costs with new schedules and reduce contractors and workforce at that mine.

[Scott Schier, Clarksons]

Okay. That's helpful. I appreciate that. And then staying on costs, but moving to thermal and then the PRB, costs were pretty impressive this quarter. But I think part of that was due to less maintenance expense. Do you kind of see this cost level is being repeated more through the remainder of the year or should we expect them to require in the quarters?

[Glenn Kellow, President and Chief Executive Officer]

Well, I'm not sure we singled out maintenance expense. But look, the team has done a fabulous job across our entire U.S. thermal platform in being able to respond to significantly lower volumes. We might – we started to – when we sold a lot of natural gas prices and the impact on demand that was occurring in that first quarter, I think we've taken steps to respond. It's also a part of our ongoing cost improvement program that's really across the entire business, but I think clearly the U.S. thermal activity has really has really stepped up. And I would say that what we are looking at is sustainable cost improvement. Now it's fair to say that we've got some particular surface operations. We've got some tailwinds with respect to low of diesel process. But we are looking – not withstanding that we are looking at ways in which we can capture sustainable costs not only for the next six months, but over the life of mine plans.

[Operator]

There are no further questions at this time.

[Glenn Kellow, President and Chief Executive Officer]

Well, thank you. And thank you all for participating in today's call. I'd like to especially thank you all employees for their continued dedication to reducing your quality products and for the heighted commitment to health and safety. Even with multiple changes to the business, you've all shown the ability to quickly adapt. I'm grateful for the unwavering focus as we adapt to a new global landscape. So, please stay safe and well. And operator, that that concludes today's call.

[Operator]

This concludes the Peabody Energy Q2 2020 earnings call. Thank you for participating.