Peabody Energy Corp (BTU) 2013 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Peabody Energy first quarter 2013 earnings call. For the conference, all the participants are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time.

(Operator Instructions)

As a reminder, today's call is being recorded. With that being said, I'll turn the conference over to the Senior Vice President, Investor Relations and Corporate Communications, Mr. Vic Svec. Please go ahead.

All right. Thank you, John. And good morning, everyone. Thanks very much for taking part in the conference call today for BTU. With us our Chairman and CEO, Greg Boyce as well as Executive Vice President and Chief Financial Officer Mike Crews. We do have some forward-looking statements. They should be considered along with the risk factors that we note at the end of our release, as well as the MD&A section of our filed documents, and we also refer you to Peabodyenergy.com for some additional information. And with that, I'll now turn the call over to Mike.

Thanks, Vic, and good morning, everyone. Peabody delivered first quarter performance that exhibits the strength of the platform amid challenging markets. And we continue to make progress on our key focus areas of cost containment, capital discipline, and debt reduction. Overall, we exceeded the top end of our targeted adjusted EBITDA range, held the line on costs in the US, and reduced Australia costs by 10%. Lowered our quarterly capital spending nearly 70% from the prior year, and we are paying down another $200 million in debt, which will bring our total repayments over 12 months to more than $600 million. Let's review the quarterly results in more detail, beginning first with the income statement.

First quarter revenues totaled $1.7 billion on shipments of 57 million tons. Adjusted EBITDA of $280 million exceeded our targeted range due to strong cost containment across the platform. Compared with the prior year, our results were impacted by market conditions that led to lower customer shipments in the US, and price declines in Australia. Adjusted EBITDA from US mining operations totaled $273 million, and Australia contributions of $100 million were impacted by significantly lower pricing, partly offset by higher volumes and lower costs. Trading and brokerage and resource management results totaled $18 million. The trading business was impacted by the continued lack of volatility in sea borne thermal markets and lower realized margins on export volumes. Both diluted and adjusted diluted loss per share totaled $0.05, reflecting lower pretax contributions as well as higher DD&A and ARO expense due to the larger volumes and operating footprint in Australia. For the year, we continue to expect DD&A levels approximately 10% higher than the prior year.

Looking at additional detail within our supplemental schedules, US volumes declined 12% from the prior year, largely due to reductions in the PRB. US revenues per ton were stable, as a higher mix of Midwestern volumes offset western revenue declines due to lower realized contract pricing. We still expect full-year US revenues per ton to be some 5% to 10% below 2012 levels. US costs per ton were largely in line with the prior year despite lower production reflecting our ongoing cost containment efforts. We also benefited from a mix shift toward lower cost operations in both regions. We expect full-year costs to be approximately 2% to 3% lower than the prior year.

In Australia, volumes increased 26% over the prior year on completed expansion projects of Wilpinjong and Millennium as well as higher productivity from the PCI operations. The increased sales volume was overcome by $250 million in price impacts versus the prior year. Australia [in unit] revenues declined 32% to $89 per short ton due to lower realizations for both metallurgical and thermal sea borne coal. Net prices for high-quality hard coking coal were settled at $235 per metric ton a year ago compared to $165 per ton in the first quarter. And sea borne thermal fiscal year contracts in the prior year were $130 per metric ton compared to $115 per ton this past year. We also experienced lower pricing on spot sales and increased domestic thermal sales. So during the quarter, we shipped 3.6 million tons of met coal at an average price of $124 per short ton, and we sold 2.7 million tons of sea borne thermal coal at an average price of $87 per short ton.

Australian costs declined 10% versus the prior year to $77 per ton. Cost benefited from higher productivity at the PCI mines, increased volumes from Wilpinjong and Millennium, and cost containment efforts. These declines overcame external cost pressures and the transition costs for owner/operator conversions. As we proceed through the year, met volumes are expected to increase, which will modestly raise per-ton costs. We also have a long wall move planned at Wambaugh in the second quarter and moves at Metropolitan and North Quinella scheduled for the third quarter. These factors are expected to result in full-year costs per ton of approximately $80, which is an improvement from our previous targets based on the favorable performance in the first quarter. At all levels, you are seeing an emphasis on costs. We're focusing heavily on mitigating the impacts of market conditions, including pricing, external pressures, and reduced US volumes. And our first quarter results show we've already started seeing the benefit of these efforts.

So that's a review of our income statement and key earnings drivers. We also generated operating cash flows of $272 million and increased cash on hand to $630 million at quarter end. Capital expenditures for the quarter totaled $74 million. We continue to target $450 million to $550 million in full-year spend and will remain focused on reducing project and sustaining capital needs wherever possible. Our strong cash flows and capital discipline enabled us to repay $100 million of debt during the quarter, and we will repay an additional $100 million by the end of May. We will also continue to pursue additional reductions throughout the year. I'll now close with a review of our outlook.

For the second quarter, we're targeting adjusted EBITDA of $240 million to $300 million and adjusted diluted loss per share of $0.25 to earnings per share of $0.01. These ranges reflect continued cost containment efforts across the platform and higher volumes out of Australia, partly offset by long wall moves at Longbow and Twentymile. I also refer you to our Reg G schedule in the release for additional details regarding DD&A, taxes, and other line items. You'll note interest expense is expected to increase slightly, reflecting debt extinguishment costs for our early debt repayment. And as mentioned, we are pleased to lower our full-year cost guidance from previous expectations, both in the US and Australia, based on our first quarter successes and ongoing cost containment activities. That's a brief review of our first quarter performance and outlook. For a discussion of the coal markets and other updates, I'll now turn the call over to Greg.

Thanks, Mike, and good morning, everyone. It's clear that Peabody is off to a good start in 2013 and has made progress on a number of fronts. Our cost containment program is bringing real value to the bottom line. Our tight capital discipline is yielding results and we continue to pay down debt. And we successfully completed the owner/operator conversions in Australia. All of these actions continue to strengthen Peabody. Now let me provide a market overview before discussing Peabody's position. Overall, the global coal markets remain mixed, as continued weakness in Europe and constrained global economic growth impact near-term prices. Still we're encouraged by the build out of new coal generation, strong steel production out of China, and record import demand in China and India. The US coal fundamentals have improved from a year ago, as colder temperatures and rising natural gas prices result in utilities increasingly returning to coal.

Now within metallurgical coal markets, second quarter benchmark prices settled higher for the first time in nine months and the low vol PCI price spread improved to 82% as steel producers are turning more to PCI as a means to reduce input costs and improve margins. Global steel demand continues to grow as China's production rose 9% in the first quarter, supporting increased metallurgical coal imports. Longer term, we see a 20% increase in global steel production by 2017, requiring an additional 200 million tons of met coal. Growing populations and increased urbanization, specifically in China and India, continue to raise steel intensity. In China, it's expected approximately 15 to 20 million people will move into the cities each year over the next decade, driving demand for met coal use for required infrastructure.

Now, on the sea borne thermal market, we also continue to see increased import demand. China's overall coal imports rose 30% in the first quarter to 80 million tons. China's thermal imports continue to increase, as new plants are built along the coast and domestic transportation and production costs rise. India's coal generation increased 9% in the first quarter and domestic production struggles to keep up with growing coal demand, all of this supporting a 25% increase in coal imports in the first quarter. India recently surpassed Japan as the second largest coal importer, and their stock piles remain well below target levels. Germany is building a new base load coal plant to offset the variability of renewable power, high international gas prices, and closing nuclear plants. And Japan is also bringing on new generation in the second half of 2013.

On the supply side, we see additional production curtailments in both met and thermal production, as legacy fixed price contracts roll off and higher cost production is closed. Production cutbacks, mine closures, and project cancellations or delays are likely to continue in most coal exporting countries around the globe. Now turning to the US markets, we've seen a dramatic improvement in coal fundamentals from this time last year. We now project 60 million to 80 million tons of increased coal demand in 2013 as the industry reclaims the majority of demand lost in 2012 to natural gas.

Within the US markets, winter was 17% colder than last year and natural gas prices have more than doubled from last April, driving a 15 million ton increase in the first quarter coal burn at the same time the gas generation dropped 11%. Coal now accounts for approximately 40% of total generation, while gas has fallen to 24%. The supply side of the equation was also favorable in the first quarter, as US coal shipments fell 10%. The end result is that PRB and Illinois basin stock piles have improved 20% over the last year. And over the next five years, we expect the low cost PRB and Illinois basin demand to grow more than 125 million tons through greater capacity utilization and regional switching. And this is after taking into account an estimated 60 gigawatts of retirements during that time. You see, US generation only ran at 55% of full capacity in 2012. These plants can run much harder and utilities have invested more than $30 billion in new equipment over recent years to allow them to do just that.

Moving to Peabody's position, our global platform continues to focus on safe, productive operations, tight cost management, capital efficiency, and debt reduction. Peabody continues to target cost containment and with pursuing every cost savings possible and have achieved success through a number of initiatives, including changing mining methods and shifting production to increase productivity, reducing overtime and contractor usage, and rapidly repricing supply contracts, fully realizing the benefit of the owner/operator conversions in Australia and pairing our SG&A costs across our platform. Within our operations, we successfully completed the transition to owner/operator status at the Wilpinjong and Millennium mines in Australia. We also took the opportunity to convert the Wambaugh cut operation to owner-operated. Now nearly 85% of Peabody's Australian production is owner-operated. That's up from 35% last year.

We're also on track to convert the Coppabella and Moorvale preparation plants to owner-operated plants later this year. These conversions allow Peabody to reduce operating variability and costs, improve mine planning and coal quality. Other projects for 2013 including implementing top coal caving technology and the preparation plant upgrades at North Quinella and completing the modernization of the Metropolitan mine to improve productivity and lower costs. So in closing, Peabody's has the leading presence in the key growth regions of Australia, the PRB, and Illinois basin that enables us to supply the world's strongest markets. But we'll continue to aggressively manage costs and capital in order to deliver shareholder value. So with that review of the global market conditions and Peabody's position, operator, we'll be happy to take questions at this time.

Certainly.

(Operator Instructions)

Michael Dudas with Sterne, Agee.

First one for Greg. Could you -- when you look at the expectations for met coal demand and imports in China and India and all the good, good data points you put forth, yet pricing hasn't really reacted. Could you maybe talk about how close we are relative to excess supply that we're seeing in the thermal markets maybe from Indonesia, Colombia, and some of the outlook for Australia to start to maybe get pricing to better reflect some of these demand trends that we've been seeing?

Yes, good question, Michael. I think our interpretation of all of this is we're seeing slower ramp up of economic activity across the globe than we originally would have anticipated. We are seeing production volumes come out of the market. The other side of that equation is those reductions are probably coming out slower than we might have anticipated. Part of that's I guess to be expected with the structure of take or pays out of Australia and for folks to be generating cash. But the positive signs are is we are seeing volumes come down. And we are seeing increasing imports into China and India, albeit at a slightly lower pace on both sides than we would have anticipated. So we're still expecting that we will continue to see progressive improvement through the back end of the year.

My follow-up for Michael, could you remind us where Peabody stands on the Australian dollar, your hedging philosophy, and how much has been taken care of at 2013 and 2014 and what that variability might be as we try to model going forward? Thank you.

Sure. We -- you know, our hedging program, we do it on a rolling basis with a primary objective to limit volatility. And based upon that, we have been able to limit the volatility against the operating variability by about 50% over the past several years. So it's been successful for us. As it relates to our existing position, we're 77% hedged for the rest of the year at an average rate of about $0.90. And then looking into 2014, we're about 50% hedged based upon our current estimated operating requirements.

Similar numbers?

To a traditional program?

No, I mean the value.

Oh, the rate. I'm sorry. Yes, it's right in line with that. It's been pretty consistent over the past several periods, even with the movement in the A dollar.

Great. I appreciate. Thank you, gentlemen.

Shneur Gershuni with UBS.

My first question, I was wondering if I could build on Mike's question a little bit and talk about the coal markets. You had brought up some interesting stats about the Chinese imports. I was wondering if you had some timing as to when you thought things were going to pick up a little bit in the met market. Is it a quarter or two from now or a little further? And then I was also wondering if you can touch on the US as well, too. Some pretty interesting commentary in your prepared remarks today about where you expect coal burn to be in the US. You know, when would you expect PRB pricing, for example, to potentially start to move up, let's say, as we think about 2014 and so forth?

Okay. Well, let me talk maybe a bit about the met markets first. As we indicated, China had a very strong quarter. Their steel production is up very strong from last year and where we've seen more chronic weakness than we would have anticipated continues to be out of the European sector and, if you will, ex-China production of steel. We see out of Japan, out of Korea, out of Taiwan, we see that our view is that they will begin to accelerate through the last three quarters of the year. China will remain strong. Europe, I think our anticipation is going to be mostly flat through the back half of the year. So it's really the Pacific Rim that's going to drive the metallurgical coal markets and, as I say, we see strengthening through the back end of the year in the met coal markets. On the flip side of that, I think now that we've got a lot of legacy contracts from last year that have rolled off at the end of the first quarter, we'll see some additional volumes come out of the seaborne market through some of the high cost regions in the US, Canada, and even some out of Australia. So the market dynamics, we think, look favorable for met coal. On the seaborne thermal side, again, we're seeing new demand through the course of the year. China's had slightly lower coal generation increase because they have had strong hydro. That could easily switch to normalized rates for the next three quarters of the year. And we're starting to see supply as well, both out of the East Coast of the US and out of Australia from the high-cost producers now that we have the new thermal settlements at $95 a metric ton. So, again, when you look at both the supply and the demand dynamics in thermal coal, we think we'll see strengthening through the year.

Now coming back into the US, the inventories have come down certainly out of the Powder River Basin, the Illinois basin, which are the two sectors that we watch the closest and affect our business the most by some 20%. Production overall is down almost 10%. If you look at those inventories, they have come down 20%. They are in the mid to upper 60s. You know, we need to see continued decline in those inventories, down into the 50s, I think, before we'll start to see marked changes in price. We'll start to see our sense, prices will begin to creep up but really accelerate once we breach that 60-day supply and get down into the mid to lower 50-day supply. But you know all of that can change very rapidly. I mean, we're sitting here in St. Louis and basically under flood watch. We've got record late spring snowfalls in the upper Midwest. There could be interruptions in supply due to weather through this quarter, which could impact also how quickly those inventories come down. So -- but right now, given normalized rates, what we've seen in the first quarter, we would expect the back half of this year to see movement, which is positive for settlements for pricing for 2014.

Great. And one follow-up, if I may, just with respect to the balance sheet and so forth. You had a pretty strong quarter. PRB pricing is poised to move higher. Met's stable potentially. Australian costs are down a little bit. You paid down $100 million of debt last quarter. The expectation is to do another $100 million this quarter. Is there a net or a target net debt-to-EBITDA number that you're looking to hit before you do start thinking about maybe redirecting to share buybacks just given the fact where the stock price is relative to where it was at the beginning of this year?

Yes. We've -- with the changes that we've seen around variability and on EBITDA that has raised the debt-to-EBITDA ratio, first and foremost, we look at the credit agreement and what the limitations are there and we have had those relaxed through the end of 2014. I can't put a hard number on it. What I can say is that debt reduction is our primary focus here and what you have seen us do here at the end of the first quarter and going into the second quarter is the first of two-pronged approaches, which is really cost containment, margin improvement, capital discipline, take that excess cash, continually pay down debt. So I don't have a hard and fast target. We've had some pretty healthy or very good debt-to-EBITDA ratios traditionally that we would be looking to try and get back to over time and some of that is a function of what we can do on the debt repayment side and some of it is a function of market condition. But we're pleased with the progress that we're making and we hope to continue that as well.

Jim Rollyson with Raymond James.

Actually following up a little bit on some of Shneur's questions, on the debt reduction and CapEx side, it looks like you were kind of spending a little bit below your full-year CapEx rate this quarter. Just maybe walk through kind of how you see CapEx over the next three quarters. If I'm not mistaken, you've got a fairly decent amount of LBA payments in the second quarter and the third quarter trails off. But -- and also, how you're thinking about debt repayment in the second half, just with what you guys see today.

Yes, so we were at $74 million on capital expenditures in the first quarter. We're guiding to $450 million to $550 million, so obviously that's back end weighted, with some of the major projects. There's a bit of a carry-on on the owner/operator transition. We've got some ancillary equipment, some facilities to complete the modernization of Metropolitan. That's why you see us taking the opportunity now for the debt repayment. We'll look to see how much of that gets spent in the back half of the year. That will influence what our debt reduction targets are. But those are probably the big drivers there in terms of the timing on CapEx. We do have the LBAs in the second half of the year as well, as you noted. Again, all I can do is say that we'll continue to look at the timing of that. We'll look at whether CapEx gets pushed into 2014 from 2013. We'll look at our earnings outlook and then that will drive our debt reduction targets for the second half of the year.

And beyond this year, just given the challenging market conditions, if things were to stay soft into 2014, how long can you stay down here at these depressed CapEx levels before you have to start picking back up to maintain production?

We've still got some run rate on that, Jim, into 2014. Obviously, the project capital, which is always a big component and has been a big component in the past if the market remains soft and we continue to defer project capital and we continue to scrub our sustaining capital going forward.

Okay, and just one quick follow-up on PRB. You talked some positive things obviously with demand for the winter with gas prices being double where they were and hopefully things normalize in inventory, especially for PRB. If and when prices start going back up, back into that mid to low 50 days kind of inventory range you're looking for, with gas at $4-plus, what do you think the upside is on PRB prices if things materialize in a good fashion and how do you think the industry responds? Do you think people stay disciplined, or do you think production chases that price back up to cap it maybe?

Well, I think once we get our inventories back down to normal run rates, and how quickly that occurs remain to be seen, we expect a very nice rebound in PRB pricing. You just go back and look through history and see where there is -- on an equivalent basis, up to $4 to $4.50 gas, there's significant head room for PRB pricing to go up. In terms of the response I think we talked a bit the last time. Our sense is people will have a bit of ability to increase overtime and run their existing equipment a bit harder. I don't think -- it's my own sense that there's a fair bit of equipment that's parked. I would not say that 100% of that is in operable condition. It's going to take time for repairs to that equipment to bring it back up into an operating condition. So you might see an initial increase based on employee overtime, running the existing equipment a bit harder, but then it's going to take some investment to bring back another tranche of rolling stock that's there.

And then because people have not been buying equipment to offset the natural stripping ratio increases that occur in the Powder River Basin, to get much higher than a -- even if you ran all the equipment that was repaired and available from a year ago, you wouldn't be able to get to a year ago's production levels until you got brand-new equipment, given that natural increase in stripping ratio that you have to move. So it's going to take some time to where people could fully, fully get up and so that I think bodes well for not getting a spike, all of a sudden getting a flood of production, and then prices tapering off.

Great color, Greg. Appreciate it.

To supplement a little bit on that, you'll recall that we've noted that the vast majority of plants that use PRB coal are competitive in that $2.50 to $2.75 range for natural gas prices. So obviously, the $4-plus range is very supportive of additional PRB burn. That's exactly what we're seeing out there. The price has moved 60% up from its trough on a spot level, but obviously not back to the levels that would be viewed more reasonable and competitive with that $4-plus gas level. That's something that once the shock absorber of additional inventories are burned down, you would expect to see result in that price movement. And we have seen so far year to date a draw of about 8 million to 10 million tons on the stock piles. That's versus a normal build of about 2 million tons during that time. So clearly, the combination of weather and the competitiveness of PRB coal in particular versus natural gas has been very supportive of that and we would see that trend continue.

Mitesh Thakkar with FBR.

Congratulations on the quarter. My first question is just on the exports. You mentioned that you will see some pullback in the exports from high cost basins. How do you think US exports play out for the industry and for you on the steam coal side year-over-year?

Currently, our view is we'll probably see about a 25 million ton reduction in exports out of the US. Maybe 15 million of that would be metallurgical coal, 10 million of that would be the thermal coals. That's our best estimate at this point, based on the first quarter performance. Obviously, the first quarter benefited from folks having sales and contracts in place. I think if you look at what's occurring right now off the East Coast in particular, we're starting to see a dramatic falloff in shipments.

Just to follow up, when you look at your Australian portfolio, obviously you have some of the low cost assets. How do you think the recent pullback in PCI prices affect overall economics in terms of just your PCI part of the equation? Are there opportunities where you can think about expanding your margins by maybe moving production from one mine to another or something like that?

Well, couple of things. While overall met coal pricing had come down -- come back up a bit this quarter the spread between hard coking coal and PCI has narrowed. So the PCI does not have the same percentage reduction. But we're focused on, whether it's Millennium, whether it's Coppabella, Moorvale, our big PCI producers, we're getting significant traction on these productivity improvement and cost reduction programs. These are big, low-cost operations. And so really moving production between them doesn't really make a lot of sense, because they are kind of in the same league, if you will. So our focus is is to continue to look at the entire platform in Australia as well as here and what can we do to continue to drive our operations lower on the cost curve. But the opportunities on margin differentials between those Australian PCI operations, they are all pretty similar and they are all starting to run very, very well.

Justine Fisher with Goldman Sachs.

My first question is on the outlook for US coal consumption this year. So you guys are expecting 60 million to 80 million of coal consumption to come back in the US. And I know you were commenting previously about the fact that we need to draw down inventories before we see US producers start to increase their production in response. But it's interesting to me that we haven't seen higher production guidance from Peabody or from any of the other coal companies in the US, meaningful increased thermal production guidance and we're almost halfway through the year now. I know you guys can't comment to other producers, but 60 million, 80 million tons of demand, that gets inventories way below where they are now on a total tonnage basis. So why is there that disconnect between forecasts for increased consumption but not higher production forecast in the US?

I think part of that 60 million to 80 million, that's an annual number and the first quarter has already delivered a big component of that in terms of coming out of inventories. It's our estimate that at that -- given that 60 million to 80 million number, given what we see for the run rate for the rest of the year, that gets inventories into that normalized range towards the late part of the year. So I'm not sure you would have expected to see folks jumping out today. Certainly, we're not going to jump out today and begin to make changes in our PRB production forecast. That may occur middle of the year, it may occur in the third quarter. But we're not quite ready to do that, given how we see the dynamic currently playing out in the latter part of the year.

And then my follow-up question is on the 2014 contracting period. I know you had mentioned earlier that the draw down of inventories this year could create good conditions for contracting into 2014. With the recent spike in gas, have you guys started having conversations with utilities about 2014 sales? Are they starting to commit? Or are they having a wait and see approach? And do you think that the utilities' approach to the market is going to be similar to what it was in previous years where they will be willing to sign call it three- to five-year contracts somewhat above where spot is? Or are they going to be less willing to sign higher priced and longer-term contracts because of the interplay between coal and gas?

Yes, the only real dynamic I think we're seeing with the utilities is less of the three- to five-year contracts. They are starting to shorten up a little bit, two- to three-, maybe four-year contracts. That's really the only change in the dynamic. I think that we're probably still going to see the normal contracting season for the subsequent year is not really going to get started until May, June, July, August timeframe. We've -- we think there's going to be some additional volumes that are going to be needed in the back half of the year. That will be the first focus here in the next, probably the next month to six weeks. And then for 2014, we're looking at a summertime event. I still think the utilities will look at what the summer burn looks like and how that may impact their view of where inventories will be going into 2014.

Okay, and if I may, just one more question on Patriot Coal. I know there have been some headlines recently about the potential liability for Peabody from Patriot. Can you guys just give us an update on what your expected potential liability could be from the Patriot bankruptcy? I know that they're -- you've put out some numbers in your 10-K before as to what the total liability could be. Has that changed a lot, or what's the updated status that we can get a good idea of what you guys might be responsible for?

I will just tell you that absolutely nothing has changed in terms of our view of what those liabilities are as we continue to report. It's about $150 million that we talk about, which is a possible black lung liability. Patriot still has primary liability for that. There's still -- as long as they are mining a ton of coal, they are still paying it. Everything else that you read, everything else that you hear going on is all maneuvering and blustering around their Patriot's issues with how they fund their benefit plans for the union. And so we have been consistent. We have got this black lung liability on the books, and that's our only expected liability at this point in time.

Brandon Blossman with Tudor Pickering Holt.

Let's see, going to try to see if there's any incremental information from you guys on Australian costs. And what I'm looking for here is just quarter-over-quarter directional indicators with the drivers being what I heard earlier, is the long wall moves, where the owner operator expenses hit and what quarter, whether it's Q1 or whether it's Q2, and the benefits of those owner/operator upgrades or changes. And then where are we on the Wilpinjong overburden -- extra incremental overburden removal process?

This is Mike. You're looking specifically as to our first quarter performance relative to where we think we're going to be for the second quarter? Is that correct?

Just directionally throughout the year.

Okay.

We talked on the Q4 call about a strong decrease in costs throughout the year and you guys said a very attractive number on costs in Australia Q1 here.

Okay. So our original guidance was we thought we would be in the lower $80s per ton. We came in at $77 for the first quarter. The biggest driver of that is we've had these cost containment efforts that we've really tried to expand and it's a function of the team really taking that charge on board. And they have delivered some better cost improvements earlier in the process. So that led to some benefit in the first quarter. We talked about owner/operator transition costs that you see in the first quarter that offset that somewhat. We also discussed the overburden removal that we need to do with the two properties that you mentioned. We were able to do some mine planning changes that smoothed some of that out a bit from the first quarter to the second quarter. So then you look at -- we came out at $77.

How do you end up at $80 per ton for a target for the rest of the year? We do still have some long wall moves that are going to come through and some of that hits in the second quarter. We have a move at Wambo. And then also when you look at what our met mix was in the first quarter relative to the -- what our expectations are for the back half of the year, the mix effect of a higher component of met coal will have an impact on that cost projection as well.

Arguably, that's the good news, right?

It is. Yes. On that particular line item, yes, it's going to cause an increase in costs. But overall, yes, we're pleased to be able to have a higher mix of met coal in the portfolio for the rest of the year.

From all of that, then that sounds like that $80 a ton is definitely achievable and not necessarily a stretch target. So that all sounds very positive. And then just real quick, taking the costs to the US, I heard mention of mix shift in the US helping costs. Is the 2% to 3% down year-over-year solely due to mix shift or are there some cost improvements on a dollar per ton, per quality --

We'll have some -- the dynamics in the US are -- you see the impacts of lower volume which nega -- typically would have a negative impact on costs. We've had cost containment efforts there as well. We have seen some mix shift to lower cost operations both in the Midwest and the West that helps us. So it's a combination of that, along with the cost containment programs that we have. And then talking about full year relative to second quarter, we do have the long wall move at Twentymile, so that's going to negatively impact costs somewhat in the second quarter, but we still feel good about updating our targets [debit] 2% to 3% reduction for the rest of the year.

Andre Benjamin with Goldman Sachs.

First question, there's been a lot of focus on the call on the 2013 costs. I know you can never be fully sure, but given these are long-term investments in productivity, how are you initially thinking about what this could ultimately mean for your Australia costs once all the benefits are fully realized?

You just have to look at the kind of costs that we're driving out of the platform by making these conversions, maybe just go through some of those. Obviously, every contractor had their own embedded profit margin that they were getting on these contracts, which no longer exists. All of these contractors were essentially -- were using smaller and less productive equipment than we are now running, now that we've converted to owner/operated. So you're going to get a productivity cost reduction all the way through, whether it's labor reduction costs per unit or fuel or transportation.

Then in addition, we're now doing all the mine planning. So that's -- that allows us to optimize the mine plan, actually deliver against the mine plan, and reduce variability. And variability in any of these operations drive huge swings in the cost structure. When you look at those three major components, we're expecting to continue to have improvements. Now tell me what's going to happen to fuel and all other external components and I might be able to give you an actual estimate of what the cost reduction is versus today. But I really can't do that. All I can tell you is for those things that we were paying before and being penalized before, we will no longer have.

And we made significant investments in the rehabilitation of the PCI mines that we acquired and A, you're starting to see those costs come down, and B, you're seeing the productivity improvements that we would expect to have going forward.

That's fair and definitely very helpful. If on the met side of the business, you've walked through why you think things will improve in the second half of the year. I guess, just thinking through some of the sensitivities, I'm sure you guys have to plan for some other scenarios. What do you think your production response would be if met prices stayed flat versus the second quarter or even more bearish outcome closer to what current spot levels are, around 150?

Well, we've got -- we're running a platform right now that's competitive at today's pricing and as we continue to drive down our cost base, we're giving ourselves some additional margin room. So we're not anticipating that we're going to be having to look at that. If there's going -- if there's a major discontinuity that occurs, we may have to look differently at our strategy. But right now the strategy is to continue to drive down costs, optimize and become more productive, and that expands our margin at today's environment and gives us head room if we see the unforeseen right now in terms of a softening.

And just one small clarification, today's pricing, you mean the second quarter benchmark of 170, not the spot price, right?

Correct. Spot price is going to move around a lot. It's a thinly traded market, not a lot of volume and no real commitment between the buyer and the seller. So, yes, I'm talking about the benchmark.

Dave Gagliano with Barclays.

My first question's actually related to the last one. I was wondering if you could talk a little bit more about what's behind the collapse in the spot price. I realize it's illiquid, but it has actually mattered a bit more recently. I was wondering if you could touch on what you think is happening there, why it's down to 150, how real is that number, and what do you think it means for the third quarter negotiations? That's my first question.

Well, I don't think you could find anybody around the world that would say that number is sustainable. So what it appears has happened is you just have some volumes out there that folks are wanting to move on a spot basis and there's not really any buyers right now. The folks that have contracted are in pretty good shape. Until we start to see the Japans, the Koreas, additional potential growth out of China, some firming in Europe, we're probably going to have a lot of, my view, a lot of variability and a lot of noise in that spot pricing on a periodic basis. When it gets down to negotiating quarterly pricing, it's more about, what are the market fundamentals? What's it going to take to sustain supply and what's it going to take to have a secure supply,? And that number is always historically different than what the spot price is on a particular day.

My follow-up, it looks like you priced somewhere around 9 million tons, just comparing the press releases of 2014 US volumes during the quarter. And I'm wondering if you could give us a little more color on what the prices were for those forward sales in the PRB and in the Midwest.

Yes, the vast majority of that was repriced under contracts that had repricing mechanisms in them, and there are -- we have a mix of repricing mechanisms. Some have caps and collars. Some have baskets of indices that are unrelated to spot pricing. Some are related to a basket of other sales. So -- really not in a position to give you pricing on those contracts, other than to say that the current spot markets are not indicative of where those contracts would have been settled because of the pricing mechanisms in those reopeners.

Just to clarify, meaning that the current spot markets -- meaning that those contractors sign above current spot markets or below current spot markets?

We've got a big marketing organization and I don't typically let them sign contracts lower than spot.

Okay, good. That's what I was hoping to hear. (laughter)

Brian Yu with Citi.

Greg, I've got -- I guess this is a bit of a philosophical question around PRB pricing to follow-on to what David was asking. When you look at the value of PRB coal relative to natural gas, it's certainly increased. But then there's the competitive dynamic of what the market will bear based on what your peers do versus your decision to participate. If we look at this year's average contracted price for PRB, for some of your peers that disclose their contracts, it's a little bit over $13 a ton. Throughout last year, we're seeing people strike contracts at $12, maybe down to even $11. So all that is still better than where spots are. And with the improvement in demand that you're expecting, what's -- how do you guys think about your decision to participate in PRB? Do they have to get back up to $13, $14 before it makes sense? Or is it a situation where with the increased demand, you have to maintain your market share or there's a desire to maintain the market share?

You're asking questions about when we would, if you will, begin to expand volumes to meet a rising market. At the end of the day, when the volume demand is there, it's going to get met. So to a certain degree, you want to make sure that you're not losing market share and blocking yourself out of the market. But having said that, at some point the market's going to need additional volume and I think the most recent history would tell us that we need higher prices than we've got today, even on a contract basis, before people are going to start making the capital investments or the cash investments and rehabilitation of equipment to start raising that volume up to meet that demand.

So it's interesting you talk about this differential between gas. You can look at the same thing in the Europe. When you look at the disparity between API 2 pricing and the equivalent price of coal to equal natural gas in Europe. And coal's got a run rate on the API 2 all the way up to $150 a ton. But we're not seeing the supply response necessary to capture that. At $4, $4.50 natural gas in the US, there's significant run room for PRB pricing. I don't have the exact number here, but my guess would be it's probably pushing $20 a ton or higher. So there is run room and somewhere in between where we're at today and that number, obviously people are going to make decisions as to when they are going to start spending capital to the extent that they have got the ability to do so, to bring production online, or they are going to use that additional pricing to kind of help themselves get a bit healthy in the near term.

So your sense is that we probably have to eat through this flat capacity in the PRB first before we see a meaningful move in the prices, as to the major players and as you commented, there's -- you don't really want to give up market share because it's tough to get that back. So you essentially -- demand improved, but the pricing lag will have to wait until we eat through the slack capacity?

Yes, I think what you're going to see is a bit of a step function. I think as prices begin to move, people will start to run some overtime, work their existing equipment harder to try and meet that demand. Then that -- then prices are going to have to take another notch up before people are going to start spending money for new equipment to recapture lost productive capacity due to strip ratio changes. And then ultimately for any large-scale investments in the Powder River Basin, you're going to have to have yet another third level of price increases. And I don't know exactly what those break points are, but you can certainly envision that it's going to be that step function as you go through time.

Curt Woodworth with Nomura.

Greg, with the PCI market certainly outperforming on a relative basis, as you mentioned, and it seems like some of the productivity metrics at the legacy Macarthur assets have been improving pretty significantly. It would seem to suggest that there could be meaningful profit improvement potential at those low vol PCI operations this year. I was wondering if you could help us quantify the potential magnitude of that improvement or what kind of targets you think are achievable on a profitability basis or per-ton cost basis.

Yes, when you -- we've given -- what we've tried to do is give the building blocks we could. We've given guidance for the second quarter. We've not given guidance for the full year. For the reasons that you mention on a qualitative basis around completing the rehabilitation and getting those productivity improvements in place, that's what you're seeing that helps us get to that $80 per ton cost target for the year.

Right, but specifically, around Macarthur assets, which seems like a lot of the optimization efforts have been completed, so given the size of the investment, I think $5 billion, is there any way for us to try to better understand what the upside is this year relative to last year for those -- that specific deal?

You have to remember that prices are lower than they were last year, even though the gap between PCI and hard coking coal has been reduced. We just aggregate PCI as part of that platform down there. We're not going forward, going to be breaking those assets out and saying those couple of mines have a certain amount of earnings power. But as I said, if you look year-over-year, we've got much stronger productivity. The team has done a fabulous job at the rehabilitation program, but we've also had revenue erosion because of price.

And then on the PRB side, when you look at spare capacity in the industry, what is the amount of spare capacity you guys have that is, say, the first tranche that's relatively easy to bring back online and then maybe what is the second level of capacity where you'd have to make more significant capital investments and that would be more cumbersome?

That's the million dollar question that everybody would love to know the answer to, but I think we'll keep that one to ourself, if that's okay.

Paul Forward with Stifel.

On your Illinois Basin results in the first quarter, or $17 per ton margins, I think that's about as good as I've seen from Peabody and the pricing was about even with year ago. I was wondering if you could talk a little bit about your overall guidance of 5% to 10% down pricing in the US in 2013. What -- I think what that all implies is a fairly significant stepping down of price realizations as older, higher priced contracts roll off and you have to re-price to the market. Are we right in saying that first quarter pricing might be a high water mark for that region and then maybe secondly, what is the prospect as you look to signing the remaining 40% of the US business that's unpriced for 2014? What's the prospect for holding up those margins at those outstanding levels we saw in the first quarter through either the fact that you've cut costs, you're rotating out of some of your higher cost operations or a price improvement if you're correct about the inventories coming down?

Paul, you have several moving parts in there and you've captured many of the melt -- of the elements. So as it relates to revenues and the outlook for the latter part of the year, we did have a couple of mines that we have shut down out of the prior year that were higher priced. They were a little higher quality, but -- so that's going to have an impact on the revenue. When you look at the margin per ton we had, some of that was a function of the cost reduction that we were able to obtain. So you've got a mine like Bear Run that's come in at sufficient volume that's got good contracted prices that's a lower cost operation, so that's benefiting us on the Midwest side. As you look forward into the back half of the year, we've said on a US basis we were going to be down some 3% to 5%, so it's a function, as you note, that you're going to have some contracts over time that roll off and you're going to have lower average realizations as a result.

But as you're looking into 2014 then is it likely that we'll be able to see that kind of margin again, or is that -- have we moved into an area of rolling off the old contracts and generally lower prices than what you're seeing in the realized number for the quarter than we could expect as we get into 2014, it won't be quite so positive?

Clearly on the revenue side, you're going to see contracts were repriced that are going to come in at lower levels. Then it's a function of once we get into the contracting season what the market firmness is for future revenue increases and then what we've attempted to do is shift the portfolio, move our production to lower cost operations to try and preserve that margin. It will be a balancing act between our cost containment efforts and the ultimate realization on the open position.

And we have time for one more question. Richard Garchitorena with Credit Suisse.

One quick one. I know it's early, but can you give us any color in terms of ballpark, how much tons you have committed already in the US for 2015 and when that may have been priced probably before 2012?

We've got -- when you look at the bulk of our PRB business, it rolls off every three years. So by the time you get to 2015 you're going to have that much more of an open position. I don't know exactly what the number --

I mean on an overall US basis, we're about 35% to 45% priced.

For 2015.

For 2015.

And I'll turn it back to you, Mr. Boyce, for any closing comments.

Thanks, everyone, for their interest. I'd once again like to express my appreciation to the Peabody team who delivered extremely well during the quarter, when you look at our ability to have the level of cost reductions, safety, debt repayment, and operations that we did. But I also want to thank all of you for your interest and we look forward to updating you at our next call.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.