Where Will Peabody Energy Be in 10 Years?

Source: Peabody Energy. 

To say it has been a rough year for Peabody Energy (NYSE: BTU) would be a significant understatement. This stock is down more than 90% since the start of the year. It might have even further to go given the impact that the increasingly weak coal market is having on the company's deteriorating financial situation. Suffice it to say, Peabody Energy is in a tough spot right now.

Given this backdrop, we've asked our energy contributors to look out over what the next decade might hold for the company.

Matt DiLallo: Coal is dying a death of a thousand cuts. New environmental regulations are killing off older coal-fired power plants, which is muting demand for coal. Also not helping matters is the fact that coal is losing market share to natural gas, which is both cheaper and cleaner. And if that wasn't bad enough, weakening demand in emerging markets is cutting off the one hope coal companies had to offset weaker domestic supplies.

That is causing extreme duress in the coal industry, which is oversupplied with coal. That supply imbalance isn't showing any signs of abating, which is putting even more pressure on coal prices. In fact, according to industry reports cited in Peabody's last earnings release, "over 80% of seaborne metallurgical coal supply is not covering cash costs at current pricing," meaning that producers are basically paying to supply the market with coal.

Weak coal prices, however, are only part of the problem facing Peabody and its industry peers. The main reason why prices are so weak is because producers took on a lot of debt when prices were higher to expand production in anticipation of growing demand, especially from emerging markets like China and India. However, that demand hasn't materialized and now that debt has come back to bite the industry, with several producers already declaring bankruptcy.

Peabody is working on solutions to address its more than $6 billion in debt, but those options are limited. Given the mountain of debt that Peabody has and the fundamental shift away from coal by the power industry, I don't see how Peabody Energy survives over the long term. Therefore, my prediction is that Peabody Energy will go bankrupt at some point over the next decade, with it more likely to be sooner than later.

Adam Galas: Like Matt I don't see many ways for Peabody to survive the current downturn in coal especially with that untenable mountain of debt. Which brings me to my prediction that Peabody will try to pay down that debt by selling assets in order to survive; albeit, as a far smaller company.

The problem for Peabody is the, while it does have some valuable assets I don't think it will find many willing buyers. For example, its most attractive assets are its low cost reserves in the Illinois Basin and Indiana , which total 2.2 billion tons and are worth $92.4 billion at current market prices .

A profitable competitor such as Alliance Resource Partners (NYSE: ARLP) and its general partner Alliance Holdings GP (NYSE: AHGP), that are some of the largest producers in that region would likely be interested in acquiring some of those reserves. However, Alliance Resources isn't likely to bail out Peabody because it knows it could snatch up those reserves a lot cheaper at a Peabody bankruptcy auction. For example in February of 2015 Alliance purchased 84 million tons of coal reserves (worth $3.5 billion at current market prices) from bankrupt Patriot Coal for just $27 million or 0.8 cents on the dollar.

This just goes to show what kind of tough spot Peabody is in. In order to survive Peabody needs to transform itself into a low cost coal producer. Yet 41% of its owned and leased reserves are in the high-cost and unprofitable Powder River basin , and much of the company's high overhead is a result of high legacy costs such as pension expenses which can't be renegotiated except in bankruptcy court.

Jason Hall: Whether Peabody Energy is still around in a decade may still be up for debate -- I'm not 100% convinced that the company will fail -- but one thing is certainly clear: If the company does survive, it will probably be a product of getting much smaller.

The issue today? A combination of the shrinking demand my colleagues mention, a debt pile that has more than tripled in the past decade, and an industry in shambles. If Peabody was the only coal company facing these challenges, it would be easier for management to offload assets to reduce expense and pay down debt.

But Peabody is just one of many troubled companies in the industry, and what's looking like a secular decline in demand, as Adam mentioned, means that there are too many assets available to buy and too few potential customers to buy them.

The irony? Peabody's debt could actually keep the company from going belly up in the near term, simply because the note holders will be motivated -- in the awful environment that exists today -- to keep the company solvent as long as possible in the hopes that things get better and they can salvage at least a few more pennies on the dollars they've sunk into the company.

Will it work out? I can't say for sure. But I'm reasonably sure in this: Investing in Peabody today will almost assuredly be a losing investment in 10 years.