Arch Coal (ACI) reported Q4 2013 and full year 2013 earnings today. Q4 2013 came in slightly below expectations on earnings (-$0.45 vs -$0.39 expectations) and revenues ($719.4 million vs $764.4 million expectations). This was somewhat to be expected since Arch Coal had warned a couple of weeks ago that due to rail disruptions its Powder River Basin volumes would be lower than expected and costs would be higher than expected.
There are, however, 2 additional takes which are less obvious from the ugly numbers Arch Coal reported. These are:
We might be in a cyclical coal bottom
For cyclicals, it's always darkest before dawn (or brightest before dusk). And while it's been dark for years now when it comes to coal, there are at least some positive signs in the horizon. These concern mostly thermal coal. I've already written on how high and rising natural gas prices favor thermal coal, through the dispatching process where coal-fired generators will tend to run more often and natural gas-fired generators will be dispatched less often. Arch Coal sees the same strengthening of the thermal coal markets (bold highlight is mine):
Arch expects U.S. thermal coal markets to tighten further in 2014, with favorable weather trends and healthier economic activity driving increased power demand. In addition, elevated natural gas prices compared with prior years should ensure that western coals - as well as most eastern coals - are competitively priced for power generation. Even with growth in U.S. coal supply, Arch projects additional drawdown on coal stockpiles during 2014. If such a drop in stockpiles occurs, coal inventories at thermal customers would fall to levels not seen since 2005.
While thermal markets are gaining momentum, global metallurgical coal markets remain weak. However, seaborne metallurgical prices are likely at unsustainably low levels, making it difficult to justify ongoing and new capital investment. While new global metallurgical coal supply entered the market during 2013 and must be absorbed, incremental production increases going forward should be largely offset by rationalization of higher-cost metallurgical supply. These trends should tighten metallurgical markets in the future.
Furthermore, Arch Coal reinforces this thesis by calling attention to the thermal coal stockpiles, which are at their lowest level since 2006. This, too, is compatible with a cyclical bottom:
Domestic thermal coal market fundamentals improved over the course of 2013. According to internal estimates, U.S. coal consumption for power generation rose by more than 35 million tons in 2013, while U.S. coal production totaled 984 million tons, the first time since 1993 that domestic coal supplies fell below the 1-billion-ton mark. As a result, U.S. power generator coal stockpiles fell meaningfully over the course of the year, and reached the lowest year-end level since 2006 of approximately 148 million tons.
We thus have a catalyst for higher thermal coal prices, and stockpile fundamentals which reinforce that catalyst. It wouldn't be surprising to see coal stocks with the greatest exposure to thermal coal improve significantly even before their financials improve.
Capex is still going down
On the other hand, things are so aggressively bad right now that Arch Coal expects to continue to tighten its capex budget. Already it reduced capex nearly $100 million from 2012 to 2013, and now it expects to cut nearly another $100 million, or a further 1/3rd, from 2013 to 2014.
Currently, Arch anticipates that 2014 costs in the Powder River Basin will be slightly higher than 2013 levels, offset by lower estimated costs in Appalachia. Arch also expects a reduction in general and administrative expenses in 2014 versus 2013 levels. Capital expenditures totaled $297 million in 2013, which was nearly $100 million less than the company spent in 2012. For 2014, Arch currently expects capital spending of less than $200 million, inclusive of $75 million for scheduled payments for land reserve additions.
Again, this is what a cyclical bottom looks like - companies going bankrupt and companies cutting capex. But it also bodes badly for those supplying that capex, including Joy Global (JOY).
Arch Coal's earnings, while below expectations, continue to paint a picture of a cyclical bottom. A picture which is greatly helped when it comes to thermal coal, where weather and rising natural gas prices make it a virtual certainty. This is then helped further by the lowest thermal coal inventories since 2006. Given this picture, I once again bought into Arch Coal during the pre-market session, as I explained in the comment section of my previous article.
Finally, while a cyclical upturn seems to be ongoing (at least in thermal coal), capex is still being reduced and thus it's early to be positive on capital equipment suppliers to the industry. If the cyclical upturn is confirmed, further down the line it will be their turn to see some optimism.
Additional disclosure: I also have calls on ACI.