Arch Coal Remains A Long-Term Buy

| About: Arch Coal (ARCH)

Arch Coal (ACI) is among the most diversified coal companies of the U.S., with substantial coal reserves of more than 5 billion tons. The company has lost almost 47% of its market capitalization year to date and 86% in last two years. The drop in value for the company is consistent with the prevailing hard business environment for the coal industry. The ongoing storm faced by the coal industry has emerged due to a hostile political environment in the U.S. towards coal, lower natural gas prices, weak economic conditions; all of these factors have resulted in lower demand for coal and have led to excessive coal supply in the recent past.

As the coal markets have been weak, bottom line results for the coal companies have remained negative. Financial flexibility and liquidity both have been the important problems faced by the coal industry lately, and remain overhang on the stock prices of coal companies. The coal companies have been looking at different options including equity issuance, sale of non-core assets and amendments in credit agreements to strengthen their balance sheets.

In efforts to increase financial flexibility and boost liquidity in the face of weak coal market conditions, last week ACI announced plans to sell its Utah mines for $435 million to Bowie Resources. The announcement seems to be consistent with the company's intentions to divest some of its non-core thermal coal assets and optimize its asset base. The divestiture announcement will bode well for the company, as the company was required to maintain high capital costs in the Utah operations going forward, which would have been difficult, given the existing turmoil in the coal markets. Also, the transaction would allow ACI to focus on the most value enhancing segments of the business.

By the end of 1Q'13, ACI had total available liquidity of $1.3 billion, and with the sale of Utah mines, total liquidity will improve to $1.7 billion. If the company decides to use total sale proceeds to pay off a portion of its outstanding debt, it could possibly reduce total debt by almost 8.5%. Currently ACI has total debt amounting to $5.11 billion and total debt to equity of 180%. By the sale of Utah mines, ACI is also expected to save approximately $200 million in capital and administration spending from 2014 through 2017.

One negative aspect of the transaction is that the assets ACI is planning to sell in Utah are profitable ones, which are expected to produce 9 million tons of coal and $90 million of EBITDA in 2013. The completion of transaction means the company will be foregoing about 20% of its current EBITDA. However, I believe there are more positives from the transactions as compared to negatives. As stated earlier, this will help ACI to focus on core operations. In addition, the cash generated from the transaction will help the company survive for longer until a recovery in coal markets reduces the likelihood to opt for additional debt financing and keeps ACI in compliance with debt covenants.

I believe if the company continues to focus on its core business assets and improves operational efficiency, bottom line results for ACI will improve. Also, ACI is expected to benefit from recovery in the coal market and offers investors a potential price appreciation, as it is currently trading at depressed valuations (P/B of 0.3x and P/S of 0.2x). Moreover, reversal to coal from gas has started by electricity producers (due to increase in natural gas prices); that will strengthen demand for thermal coal and support coal prices. Furthermore, improvement in coal supply management will also be beneficial and supportive for the coal industry and therefore for ACI. I remain bullish on ACI for the long run.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.