Rise In Coal-Fired Power Generation To Brighten Arch's Future

| About: Arch Coal (ARCH)

Arch Coal (ACI) is among the leading coal companies of the U.S. The coal industry has been going through a rough patch as of late due to weak coal demand and oversupplied coal markets. Lower natural gas prices have prompted higher natural gas electricity generation, resulting in lower coal-fired electricity generation, which has in turn taken a toll on the stock price. However, the company has been taking aggressive measures to lower its operation costs and preserve cash to survive the ongoing tough business conditions, which will portent well for the company's bottom line results. Also, an expected rise in natural gas prices will result in a rise in coal demand. Therefore, I believe the worst is priced in and the company remains an attractive long-term investment option for investors looking to play a coal market rebound.

The company has been struggling to post a healthy financial performance in recent times due to soft coal market conditions. The company reported an adjusted EPS of $0.01 for 3Q2013, down from $0.20 in the corresponding period last year, beating consensus estimates of ($0.30). ACI reported total revenues of $790 million, down 18% year-on-year, missing consensus estimates by approximately 10%. A positive takeaway from the recent quarter's earnings was the fact that total sales volume for the quarter increased 2.2% year-on-year to 38.3 million tons, indicating the recovery in coal demand. Despite the fact that the sales volume for the quarter increased, total revenues for the recent third quarter were adversely affected by lower average sales price, which dropped approximately 24% year-on-year.

Stock Price Catalysts

In the ongoing tough business conditions, the company has been undertaking aggressive measures to reduce its costs and preserve cash to survive. In response to the soft coal demand and market, the company has been idling high cost mines to lower its cost curve, and has been allocating those resources to mines and operations that can efficiently compete in the current tough conditions. ACI was successful in lowering its cash cost per ton almost by 20% year-on-year to $16.51 in 3Q2013. Also, in the recent third quarter, ACI reduced its total operating cost per ton by 18% year-on-year to $19.37 and reduced its full year 2013 cost guidance, as it expects its cash costs to decrease in Appalachia and PRB from $65.5-$69.5 and $10.45-$10.85 per ton to $65-$69 and $10.40-$10.6 per ton, respectively. The company's management indicated that it has been working to identify areas for additional long term and sustainable costs savings, which will support the future's bottom line results. The company has also been reducing its capital spending to support bottom line results and preserve cash.

In response to the prevailing business conditions, the company lowered its sales volume guidance. To address the concerns of an oversupplied coal market, ACI lowered its full year 2013 met coal sales guidance to 6.9-7.3 million tons from the prior guidance range of 7.7-8.3 million tons. The efforts of coal companies to curtail coal supply will portent well for coal prices and the industry. U.S. coal production has been decreasing in response to soft coal demand and weak coal prices. The following chart, taken from the last quarterly coal report published by the Energy Information Administration [EIA] shows that U.S. quarterly coal production has been decreasing in recent quarters.

Source: eia.gov

Moreover, an expected rise in natural gas prices will lead to higher coal-fired electricity generation in the future. According to the Energy Information Administration, natural gas prices are expected to rise above $4 mmBtu in the future and coal-fired electricity generation is expected to rise to 39.4% and 40.2% in 2013 and 2014, respectively, as compared to 37.4% in 2012. As coal-fired electricity generation increases, it will portent well for ACI. The following chart shows coal-fired electricity generation projections by the EIA.

Source: eia.gov

Furthermore, the company has been selling its non-core assets to boost its liquidity and improve its financial flexibility. In the recent third quarter, the company completed the sale of its subsidiary, Canyon Fuel Company, which increased ACI's total liquidity to $1.6 billion, including $1.4 billion of cash. I believe the company has a strong liquidity position and there is minimal risk of bankruptcy as there is no debt maturity until 2016. The company's strong liquidity position remains an important stock price driver. The following chart shows ACI's debt maturity profile.

Source: Investors Presentation

I believe the company's effort to reduce cost and preserve cash will have a positive impact on the stock price, as we move forward. Also, demand for coal is expected to strengthen due to economic recoveries of key international markets and the expected rise in natural gas prices. Moreover, current valuations remain attractive for ACI, as the stock is currently trading at price-to-sales of 0.25x and price-to-book of 0.35x. Therefore, I believe ACI remains an attractive investment option for long-term investors.

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.