Why Peabody Energy Stock Has Crashed 20% in 2014

Peabody, along with other coal companies, is suffering from regulatory pressure on coal and utilities switching to natural gas.

Aug 26, 2014 at 5:25PM

Coal companies are truly under fire this year. Increasing public and regulatory scrutiny of coal-fired power plants is putting the future of coal in jeopardy. Making matters worse is that certain industrial customers of coal, such as electric utilities, are turning away from coal in favor of cheap and plentiful natural gas.

Put it all together, and profits are collapsing across the coal sector. This is why many coal stocks have taken it on the chin to start 2014. Peabody Energy Corporation (NYSE:BTU) is down approximately 20% so far this year. Here's why.

Peabody under pressure
Last quarter, Peabody managed 2% revenue growth, thanks mostly to a 1% increase in sales volumes, which hit nearly 62 million tons. Unfortunately, worsening performance in the company's international segment, as well as high operating costs, led to a net loss. Peabody's Australian business reported 5% lower revenue last quarter because of lower pricing.

In addition, the company's loss from continuing operations totaled $72 million, which was much poorer performance year over year. In the same period last year, Peabody reported $101 million in net income from continuing operations.

The same thing is afflicting other coal companies as well. Coal producer CONSOL Energy (NYSE:CNX) reported weaker metallurgical coal conditions, which led to lower pricing in that market. In addition, it also saw lower pricing in thermal coal, although that was somewhat offset by higher thermal sales volumes.

Even worse are the new regulations in the United States that have the potential to do significant harm to Peabody's business going forward. As Peabody stated in its most recent earnings report:

"The U.S. Environmental Protection Agency has proposed carbon dioxide rules that would require states to reduce emissions from existing electric generating plants. Should the rules be finalized in their current form, third parties have projected the potential for negative impacts to generation, consumer electricity rates, jobs and economic development."

This clearly puts a dent in a near-term recovery for Peabody Energy.

Management counting on cost cuts
Peabody is clearly not too optimistic about its operations in the United States. In response, the company has little choice but to aggressively cut costs to keep profits afloat. The company reduced its capital spending target this year to $210 million-$250 million. This will result in U.S. costs per ton being 1%-3% below last year's levels.

Despite this, Peabody management still expects the company to lose between $0.40 per share to $0.53 per share. That's because U.S. revenues per ton are expected to decline by 4%-7%.

The fact that revenues are expected to decline faster than costs is why earnings will continue to fall.

Plus, cost initiatives can't last forever. At some point, Peabody needs to grow, which looks doubtful considering the regulatory scrutiny of coal.

The Foolish takeaway
It's no secret that the coal industry in the United States is under fire. A multitude of industry headwinds threaten the very future of the coal industry. These include the attractiveness of natural gas as a replacement for utility customers, and ongoing regulatory pressures that will significantly affect the likelihood of new coal-fired plants being built in the United States.

This has brought nearly the entire sector to its knees, and Peabody Energy is no exception. Shares of Peabody Energy are down 20% just since the start of this year. Making matters worse is that going forward, these conditions don't appear to be improving.

In response, Peabody Energy is resorting to expense reductions to keep current profits afloat, but those initiatives are coming at a severe cost to future growth.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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