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Arch Coal (ACI) is currently trading at lower valuations, P/S 0.3x and P/B 0.4x, due to the recent adverse performance of the U.S. coal industry. However, analysts are expecting earnings growth for ACI in the future as shown in the table below which is likely to result in price appreciation in the long run for the stock. ACI is the most diversified coal producer and holds the second largest coal reserves of 5.6 billion tons in the U.S. Also, more than 70% of the company's sales volumes are attributed toward low cost Powder River Basin. The following charts show diversified mine portfolio for ACI.

(click to enlarge)
Source: Investors Presentation

Industry Analysis
Lower natural gas prices, rising regulation concerns and slow manufacturing activities led to depressed coal demand and prices in 2012. ACI stock was among the worst performer in the coal industry in 2012 as it was down almost 50%. Coal ETF (KOL) was down 22%, whereas Peabody Energy (BTU) and Alpha Natural (ANR) were down 20% and 51% respectively.

Due to lower natural gas prices last year, coal-fired electricity generation was down as compared to earlier years. Lower coal demand by the U.S. power producer adversely affected the company's sales and earnings, as a significant portion of ACI sales are directed towards the domestic power generators. However, Energy Information Administration (EIA) is expecting that in the future, the contribution of coal in producing electricity is likely to increase. The following chart shows percentage of coal-fired electricity generation of the U.S. in past and projections for next two years.

(click to enlarge)
Source: eia.com

Financial Performance
Due to lower natural gas prices and other points discussed above, ACI's financial results of 4Q'12 and full-year 2012 were negatively affected. Following are the full-year 2012 and 4Q'12 financial performance highlights.

Full-Year 2012.
ACI reported net revenues of $4.16 billion, down 2.9% YoY. Adjusted earnings per share were down to ($0.36) as compared to the previous year figure of $1.07. Also, sales volumes were down 9.5% YoY to 140.7 tons for the year, 2012.

Full-Year 2011

Full-Year 2012

Tons Sold (in millions)

155.3

140.7

Operating Margin Per Ton

$3.66

$1.73

EBITDA Margin

21%

17%

Adjusted EPS

$1.07

($0.36)

Source: Earnings Release

Fourth Quarter 2012
Quarterly sales and adjusted EBITDA were down 21% and 73% YoY respectively for 4Q'12. Lower revenues and earnings were mainly associated with the decline in coal demand in recent times. Total sales volumes were down 3.7% QoQ, and operating margin per ton for the recent quarter stood at $1.33. The following table shows margins and adjusted EPS comparison between Q4'11 and Q4'12.

4Q'11

4Q'12

Gross Margin

23%

17%

Operating Margin

11%

(29%)

EBITDA Margin

22%

7.5%

Adjusted EPS

$0.29

($0.42)

Source: Earnings Release

Guidance
ACI is anticipating sales volume to stay in the range of 133 - 144 million tons and CAPEX is expected to be $330 - $360 million for the full current year, 2013. Following are the analysts' EPS estimates for ACI from 2013 through 2016.

Year

EPS Est. (in $)

2013

(0.99)

2014

(0.32)

2015

0.02

2016

1.3

Source: Nasdaq.com

Debt and Cash flow
ACI currently has a high debt-to-equity ratio of 180%, this is mainly due to current depressed equity value. As the market conditions for coal improve, it will likely result in lower leverage (lower debt-to-equity) due to a recovery in equity value.

Despite higher current leverage, ACI will probably not experience cash flow problems in the near future as there is no long-term debt maturity until 2016 and the CAPEX requirement is falling. Following chart shows debt maturity profile of ACI.

(click to enlarge)
Source: Investor Presentation

Conclusion
The stock price of ACI is likely to be volatile and depressed in the short term due to depressed current earnings and near-term earnings forecast; however, in the long term, I believe the stock price will increase as positive earnings of 2015 and 2016 (as shown in the table above) will be discounted back for price calculation.

The table below shows depressed valuations (P/S and P/B) for several coal stocks. ACI has attractive P/S and P/B as compared to its peers. Moreover, analysts are expecting earnings of coal stocks to grow at a decent rate as shown in the table below.

ACI

BTU

CONSOL Energy Inc. (CNX)

Walter Energy, Inc. (WLT)

Alpha Natural Resources, Inc.

Price to Sales

0.3x

0.8x

1.5x

0.9x

0.25x

Price to Book

0.4x

1.3x

1.9x

2x

0.4x

Next 5 Years Growth Rate

5%

-

12%

7%

5%

Source: Yahoo Finance

Source: Arch Coal Is A Long-Term Buy To Play A Coal Rebound