Arch Coal (ACI), the most diverse U.S. coal producer, has exposure to both met and thermal coal operations. Also, the company is the second largest reserve holder in the country; ACI has coal reserves of more than 5 billion tons. The Coal Industry has been going through difficult times, as tougher environmental regulations, lower natural gas prices and excess coal supplies have adversely affected coal prices. The tough industry conditions will keep ACI's stock price under pressure in the short term; however, in the long term, I believe the company has the financial strengthen and potential to navigate through the difficult industry condition and benefit from a rebound in the coal market. The company has been taking the right measures to improve its financial flexibility to survive through the difficult times. The company has been cutting its capital expenditures, lowering costs, extending debt maturities and reducing coal production to address the challenges faced by the industry.
Weak Met Coal Prices and Production Cuts
Excess met coal supply has been an important hurdle in a met coal price recovery. Soft met coal demand from China and excess met coal supply from Australian producers have kept the market oversupplied. A Weak Australian Dollar as compared to the U.S. Dollar has resulted in an increase in met coal output. Recently, the quarterly met coal benchmark price for 3Q14 settled at a six-year low of $120/ton, flat quarter-on-quarter. The weak quarterly benchmark price signifies the importance of more production cuts. According to Moody's, despite worldwide met coal production cuts of more than 40 million tons in the last two years, the market is believed to be oversupplied by approximately 30 million tons. I believe coal companies will continue to curtail their met coal supply in response to the weak met coal price.
Following the third quarter's met coal price settlement at the end of June, Cliffs Natural Resources (NYSE:CLF) and Alpha Natural Resources (ANR) have already announced met coal production cuts. ANR has announced that it is closing the Cherokee met coal mine in Southwestern Virginia and CLF has planned to temporarily idle its Pinnacle coal mine in West Virginia. I believe coal companies will announce additional production cuts during the earnings releases later this month. The following chart shows the quarterly met coal benchmark price.
According to the quarterly coal report published by the Energy Information Administration a couple of weeks ago, U.S. coal production totaled 242.3 million tons in 1Q2014, down 1.1% year-on-year. U.S. coal production has been consistently trending downward since 2011, as shown in the chart below. However, for a recovery in met coal prices, I believe consistent and continuous production cuts need to be observed.
As the current industry environment remains tough, ACI has been taking steps to preserve cash and improve its financial flexibility; the company has undertaken the sale of non-core assets and lowered its capital expenditure. The company's efforts to preserve cash seem to be effective, as ACI's cash burn in 1Q14 was $55 million, down from $205 million in 4Q13. The company ended 1Q14 with total liquidity of $1.4 billion, which includes $1.1 billion of cash. Also, the company does not have a significant debt maturity until 2018, which allows ACI to navigate through the tough industry environment. According to UBS analyst Kuni Chen, ACI has enough liquidity to survive the next three years in the ongoing tough industry conditions. The following chart shows the debt maturity profile of ACI.
Source: Investors Presentation
ACI remains a good stock for long-term investors to play a coal market rebound. ACI has been taking steps to preserve cash and strengthen its financial flexibility to survive through the difficult industry conditions. Also, ACI has no significant debt maturities until 2018, which will help the company navigate through the tough industry conditions. As met coal prices remain weak, I believe coal companies, including ACI, will announce additional production cuts in the upcoming earnings releases.
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