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Summary

  • The company is doing well improving financial flexibility and lower cash burn.
  • ACI’s met coal operations may remain weak in the short term.
  • Depressed current valuations make stock an attractive investment for long term.

Arch Coal (NYSE:ACI) is among the leading U.S. coal companies and has diversified operations, with exposure to both thermal and met coal. The U.S. Coal Industry has been going through a rough patch for the last two years, as a result of tougher environmental regulations, a drop in natural gas prices and oversupplied coal markets. Coal companies, including ACI, have been working to lower costs, rationalize supply and cut capital expenditure to survive the difficult industry environment. ACI is likely to benefit from dropping coal stockpiles at electricity power producers, a recovery in coal prices and an expected increase in coal-fired electricity generation. Also, with no long term debt maturity until 2018, the company has low bankruptcy risk. Moreover, the current depressed valuations make the stock a good investment option for long term investors willing to play a coal market rebound.

I believe thermal coal markets will improve as we move forward, due to an expected rise in coal-fired electricity generation and coal inventory rebuilding at power producers. Coal-fired electricity generation has increased in recent quarters and the trend is expected to continue in the future. In 1Q2014, coal-fired electricity generation increased by 2.5% year-on-year to 42.5%. Also, due to a rise in natural gas prices, coal-fired electricity generation is expected to rise by 2% year-on-year in 2014. Due to higher coal-fired electricity generation, coal prices are likely to improve and this will benefit ACI.

Due to the recent increase in coal-fired electricity generation, coal stockpiles at power producers have dropped from 156 million tons in November 2013 to 118 million tons by the end of March; this represents the lowest stockpile levels since 2006. At the end of March, coal stockpiles were at 45 days of coal burn, which was below the normal levels. Coal stockpiles are expected to further drop to around 110 million tons by the end of summers. I believe that as the coal stock levels have dropped in recent months, demand for thermal coal will increase as power producers will rebuild their coal inventory to maintain normal coal stockpiles. The following chart shows the decreasing coal stockpiles at power producers.

Source: eia.gov

The company's met coal operations are likely to remain weak in the near future, which will put pressure on consolidated earnings. Met coal markets remain weak as a result of excessive coal supply from Australia and weak Chinese met coal demand. The met coal benchmark price for 3Q2014, which is expected to be determined in the current month of June, is expected to remain weak. The 2Q2014 met coal price settled at $120 per ton, which was the lowest benchmark price in seven years.

Financial Performance
In the tough coal industry environment, the company continues to report soft financial performance. ACI reported an adjusted loss per share of $0.60 for 1Q2014, missing consensus estimates of loss per share of $0.42, as compared to a loss per share of $0.34 in 1Q2013. The company's performance in the recent quarter was adversely affected by railroad issues and soft met coal markets.

Despite the fact that the company's earnings are adversely affected by the ongoing tough coal market conditions, the company has been doing well to improve its financial flexibility. The company does not have any long term maturities until 2018, which allows it to survive through difficult coal market conditions. Also, the company ended the recent first quarter with total liquidity of $1.4 billion, including $1.1 billion in cash; cash burn for the company in 1Q2014 was only $55 million, as compared to a cash burn of $205 million in 4Q2013.

To address the oversupplied met coal market, the company lowered its met coal volume guidance for 2014 by 1.2 million tons and will be abolishing overtime and shifts at its high cost mines. The reduction in met coal supply will help address the concerns of an oversupplied market and reduce the cost of production, as production at high cost mines will be reduced. Thermal coal volume guidance for 2014 was maintained by the company at 124-132 million tons.

Conclusion
I believe ACI remains a good investment for long-term investors willing to play a coal market rebound. The company has done well to improve its financial flexibility and lower its cash burn. Also, the company does not have long term debt maturities until 2018, which will lower its balance sheet risk and help it survive the difficult industry conditions. Met coal operations of the company might remain weak in the short term due to an oversupplied met coal market; however, in the long term, met coal prices are likely to recover due to improved met coal demand and supply cuts. Thermal coal markets are likely to improve in the near term due to higher coal-fired electricity generation and inventory rebuilding at power producers. Moreover, the depressed current valuations make ACI an attractive investment for long-term investors; the stock is currently trading at a P/S of 0.25x and a P/B of 0.35x.

Source: Arch Coal - The Perfect Play Off A Coal Market Rebound