In Arch Coal: Walking Dead the thesis was put forth the company would continue to struggle going forward while being strong enough to ward off bankruptcy over the coming years. Since that time, the fundamentals and strength of Arch Coal (NYSE:ACI) have deteriorated significantly.
Recent developments suggest Arch Coal common shareholders will be wiped out in bankruptcy mid-decade. Arch Coal looks to be crushed by three circumstances:
- Natural gas prices
- Depressed cash flow
- Heavy debt
The most important ingredient in the U.S. coal market is the price of natural gas. Unfortunately, the strip is below $4 through October of 2014. Coal mining can not profitability compete with depressed natural gas prices. Environmental pressure combined with low natural gas prices accelerate the already aggressive schedule for U.S. coal plant closures. The depressed coal industry is a function low natural gas prices and a coal resurgence requires meaningfully higher natural gas.
The most probable route for Arch Coal to survive is meaningfully higher natural gas prices. For Arch Coal to thrive, meaningfully higher natural gas would need to continue on a permanent basis. Unfortunately for Arch, the new economics of drilling horizontally for natural gas mean any spike in natural gas will be short lived.
Depressed Cash Flow
In 2012 Arch Coal's cash flow as measured by EBITDA fell to $688 million in 2012 from $921 million in 2011. Interest expense was $312 million and capital expenditures were $395 million.
In the first quarter of 2013 Arch Coal's cash flow collapsed a further 53.5% to only $83.6 million. Interest expense alone was larger at $95 million. Management still expects capital spending in 2013 to be near $300 million. For Arch to capitalize on any uptick in the coal markets capex would need to be increased.
Arch Coal's recent agreement to sell its Utah Operations to Bowie Resources for $435 million should illustrate Arch's weak position. A skeptic would suggest the asset sale will only help keep the company afloat for one additional year.
Meanwhile, the $5.1 billion in debt continues to grow in size and closer to maturity. Any company which issues debt with a yield to maturity of 10.75% in a zero interest rate environment is under significant financial stress. The $42 million being paid in annual dividends is lipstick on a pig.
Bankruptcy typically arrives much sooner than expected. The March 31 cash balance of $1.0 billion and liquidity of $1.3 billion look less impressive in light of debt covenants requiring $450 million in liquidity. Expect Arch Coal to burn through this liquidity in less than two years.
Other company's in a similar position include James River Coal (JRCC) and Alpha Natural Resources (NYSE:ANR). Over the long term Peabody Energy (NYSE:BTU) will win market share, though Peabody has Austrailian headwinds. The investor who continues to insist upon involvement in the U.S. coal markets could consider Cloud Peak Energy (NYSE:CLD).