Morgan Stanley Sees Trouble In Coal Ahead, Downgrades Peabody And Cloud Peak

• Evan Kurtz of Morgan Stanley argued in a note that United States coal prices "could remain weak" for a few more years.
• Kurtz downgraded shares of Peabody Energy Corporation (NYSE: BTU) and Cloud Peak Energy Inc. (NYSE: CLD) to Equal-weight from Overweight.
• Kurtz noted both companies need an uptick in coal pricing to remain (or return to) free cash flow positive.

Coal investors looking for relief from Wall Street analysts may be disappointed as Evan Kurtz of Morgan Stanley argued in a note that U.S. coal prices "could remain weak" for a few more years.

According to Kurtz, U.S. utility coal burn is expected to fall by 75 mt year-on-year to 774 mt in 2015 and remain near that level until 2020. The analyst also pointed out that he saw a "meaningful drop" in second quarter coal production and it could take another two years to balance the market and normalize stockpiles.

Kurtz is now forecasting $11/t PRB coal in 2016 and $13/t over the long term. Similarly, he is forecasting 2016 and long-term CAPP pricing of $45/t and $48/t and ILB pricing of $38/t and $41/t, respectively. The analyst argued his 2016 price deck is low enough to "close the required oversupply over the next couple of years" while his long-term price deck is "consistent with a secularly challenged market."

Peabody Downgraded To Equal-Weight

Kurtz downgraded shares of Peabody to Equal-weight from Overweight with a $45 price target.

According to Kurtz, his Overweight thesis assumed the company would return to a free cash flow generation in 2017 – a necessary event to "allay concerns" on refinancing its 2018 notes.

Kurtz is now expecting the company to "burn cash" in 2017, but can nevertheless refinance its 2018 $1.5 billion issue at terms and costs that will likely be "onerous." The analyst also noted that the potential for a "wipe out" of the equity is "real."

Cloud Peak Downgraded To Equal-Weight

Kurtz downgraded shares of Cloud Peak to Equal-weight from Overweight with a $5 price target.

Kurtz stated that Cloud Peak is still "one of the relatively safe" coal plays, but a price recovery is now required to keep the company from burning through cash.

Kurtz is "becoming more concerned" on Cloud Peak's commitment to 6 mt of exports per year, which are secured with an approximate $20/t take or pay. The analyst stated that under the current conditions, this would drive EBITDA losses at the logistics arm of approximately $80 million per year.