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Sterne Agee Cuts Peabody Energy, Sees Bowie Transaction Risks

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Sterne Agee has downgraded Peabody Energy Corporation (NYSE: BTU) to "neutral" from "buy," citing severe headwinds surrounding the company's underlying fundamentals that have generated significant financial distress.

"Given reduced pricing, margin and volume expectations for 2016 and Peabody's significant debt load, our option value model suggests equity residual value near current prices. Therefore, we lower our rating to Neutral," analyst Michael Dudas recently wrote.

Peabody's liquidity dropped to $903 million as of February 9 down from $1.81 billion at the end of the third quarter of 2015. The company has $824 million in letter of credits (LCs) compared to $229 million at the end of third quarter, suggesting that it had to post additional LCs to collateralize bank guarantees and surety bonds.

Peabody has collateralized $390 million of bank guarantees but only 30 percent of $514 million surety bonds outstanding. Peabody recently drew down remaining capacity under its $1.65 billion revolver.

What Do The Numbers Show?

"Drawdown of revolver could send a signal the company is building up its cash reserves ahead of a bankruptcy filing," Dudas noted.

The analyst also said there are certain risks associated with the closure of the recent Bowie deal. Peabody entered into an agreement to sell certain thermal coal assets to Bowie Resources for $463 million, including $358 million in cash. The transaction is supposed to close in the first quarter of 2016.

Bowie plans to use a new term loan for funding, the commitments of which were due by February 8. Peabody's 2016 guidance does not factor in completion of the deal.

Peabody recently detailed the terms for proposed debt exchanges between the company and holders of 6 percent Notes due 2018 (nearest maturity). Debt exchange terms stipulate that debt exchange would be conditional on receipt of $500 million in cash from asset sales.

"Failure to close the Bowie asset sale transaction could jeopardize debt exchange transaction," said Dudas, who widened his 2016 loss estimate on Peabody to $33 a share from $31.50 a share. Wall Street analysts' consensus views for 2016 stands at a loss of $34.12 a share.

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