Can This Coal Company's Dividend Last?

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

The coal industry is facing something of the perfect storm, with both thermal and metallurgical coal in the doldrums. This has pushed coal companies into self preservation mode, which has included shutting mines, cutting capital spending, and, unfortunately, cutting dividends. Industry giant Peabody Energy (NASDAQOTH: BTUUQ  ) hasn't cut its disbursement yet—will it soon have to?

Good later, bad now
Peabody is projecting that by 2017 there will be an additional 425 gigawatts of coal fired electric power in the world and that steel production growth will require another 150 million tons per year of met coal. That's great, but that future isn't here today and low coal prices and weak demand, at least for domestic thermal coal, are wreaking havoc on the financial results of coal miners.

For example, Walter Energy (NASDAQOTH: WLTGQ  ) made a transformational purchase in 2011, essentially transforming itself into a near pure-play met coal miner. That turned out to be an over $3 billion purchase at the top of the market that took debt to about 50% of the company's capital structure. Weak coal prices, however, led to a billion dollar writedown, which came right out of shareholder equity.

Now, debt makes up 75% of the capital structure and the company has had to cut deals with its creditors to loosen covenants. Worse, it's has lost money for four quarters. As part of the deal that helped ensure its financial viability, Walter cut its dividend to a token penny a share each quarter.

But not that bad
Peabody, however, isn't nearly as bad off as that. For starters, the company is diversified by the location of its coal mines and the types of coal it sells, running mostly thermal coal mines in the United States and thermal and met coal mines in Australia. That gives Peabody a global profile that few in the industry can match.

Moreover, even after a billion dollar write off in 2012, long-term debt accounts for around 55% of the capital structure. And, despite the weak environment, Peabody was profitable in the second quarter. That said, it lost money in the two prior quarters, so all is obviously not well. Moreover, management sees third quarter earnings coming in somewhere between a loss of $0.16 a share and a profit of $0.09. Peabody earned $0.33 a share in the second quarter.

The dividend
Peabody pays a dividend of $0.085 a quarter. That's not huge, but the payout ratio is likely to be pretty tight this year. In fact, earnings may not be enough to cover the distribution. Looking at the coal market in mid-2012, Arch Coal (NASDAQOTH: ACIIQ  ) made the tough call and trimmed its dividend from a quarterly rate of $0.11 a share to just $0.03, increasing the company's liquidity by $68 million annually.

Interestingly, Arch's long-term debt was only around 50% of its capital structure at that time. That doesn't mean that Peabody is about to cut its own dividend, however. But the dividend does cost it over $90 million a year. That's real money when you only made $67 million in the first half of the year.

Cash flow
Luckily, however, dividends don't come out of earnings—they come out of cash flow. That's why companies can pay dividends even though earnings don't cover them. On an accounting basis, long-lived assets like buildings, heavy equipment, and coal mines lose value over time. Although that's not a real world cost in many cases, U.S. accounting standards require a percentage of the value of such assets to be "written off" each quarter.

So while Peabody only earned $67 million in the first six months of 2013, it had to record over $350 million worth of depreciation and other non-cash costs. That's money that wasn't counted in earnings but that didn't actually go away. 90 million doesn't seem like such a large nut to crack when you look at the dividend through that lens.

To give a non-coal example, Alcoa (NYSE: AA  ) trimmed its dividend by over 80% in 2009 to an annual rate of just $0.12 a share. Still, the company only earned $0.03 a share in the first half of this year. Unless the aluminum market picks up materially, earnings won't cover the dividend in 2013. But making aluminum requires large factories, leading to depreciation charges of $723 million, or about $0.65 a share, in the first half. Those non-cash charges are more than enough to cover the dividend.

Not high, but safe
Peabody's yield is only hovering around the 2% mark, so income investors aren't likely to get excited. That said, 2% is relatively high for this global coal giant. And it appears to have plenty of cash flow to cover that disbursement despite the weak coal market. For more conservative investors looking for a contrarian play, Peabody looks like a good option offering a modest, but likely safe, dividend payment.

Why is this resource more valuable than gold or oil?
Interested in resources? Then you owe it to yourself to discover the most precious resource in the history of the world. It's not gold. Or even oil. But it's more valuable than both of them. Combined. And here's the crazy part: one emerging company already has the market cornered... and stands to make in-the-know investors boatloads of cash. We reveal all in our special 100% FREE report The 21st Century's Most Precious Natural Resource. Just click here for instant access!

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2658406, ~/Articles/ArticleHandler.aspx, 9/24/2016 5:25:44 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 20 hours ago Sponsored by:
DOW 18,261.45 -131.01 -0.71%
S&P 500 2,164.69 -12.49 -0.57%
NASD 5,305.75 -33.78 -0.63%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/23/2016 3:59 PM
BTUUQ $1.58 Up +0.06 +3.95%
Peabody Energy Cor… CAPS Rating: *
AA $9.76 Down -0.02 -0.20%
Alcoa CAPS Rating: ***
ACIIQ $0.41 Down -0.09 -18.00%
Arch Coal, Inc. CAPS Rating: *
WLTGQ $0.04 Down +0.00 -2.96%
Walter Industries,… CAPS Rating: **