Arch Coal (ACI) is the second largest coal producer in the U.S. The company has exposure to both met and thermal coal operations. Coal companies in the U.S. are facing difficult business conditions due to tougher environmental regulations, weak natural gas prices and excess coal supply. Met coal prices have remained weak due to excess supply. On the other hand, thermal coal prices have been relatively flat in the recent past. As conditions in the Coal Industry remain tough, ACI has been taking the right measures to navigate through difficult industry conditions by lowering its costs, reducing CAPEX and rationalizing supply. The company reported better-than-expected results for Q2'14, mainly driven by strong cost control, indicating solid operational execution. Also, I believe the company has enough liquidity to survive the industry downturn.
The company reported better-than-expected results for Q2'14, mainly driven by better pricing in Appalachian and lower costs. For Q2'14, the company reported an adjusted EBITDA of $65 million, beating consensus estimates of $49 million. Revenue for Q2'14 came out to be $713 million, down 7% year-on-year. The solid operational execution, in the tough industry conditions, is evident from the fact that Appalachia costs dropped from $80 per ton in Q1'14 to $76.25 per ton in Q2'14, mainly due to a shift to lower cost mines and successful Leer mine ramp. Western Bituminous (BIT) costs dropped to less than $20 per ton in Q2'14 due to strong operating performance at mines. Also, cash margin for ACI improved to $2.91 per ton in Q2'14, as compared to $1.70 per ton in Q1'14. As a result of the solid operational execution, the company lowered its cost guidance for Western Bit and Appalachia by $2.5 per ton and $1 per ton for 2014. The solid cost control measures seem to be sustainable, as most of the efforts are structural in nature, like changing labor and supplier contracts, and idling high cost mines.
Despite the cost control efforts in Appalachia and Western Bit, the company continues to face rail issues in the PRB region. The company believes that it lost approximately 4-to-5 million tons of PRB shipments. Also, the company cited that rail issues adversely affected July shipments from the PRB region. The rail issues are likely to prevail in Q3'14, and will gradually improve starting Q4'14. I believe that due to the current rail issues, it is likely that ACI will not be able to ship all of its contracted coal in 2014, resulting in some rollover to 2015. However, I believe cost control in Appalachia and Western Bit will offset the cost associated to rail issues in the PRB region.
To address the concerns of an oversupplied coal market, the company narrowed its met coal sales guidance to 6.3-6.9 million tons from 6.3-7.3 million tons, and thermal coal shipment guidance to 124-130 million tons from 124-132 million tons for full year 2014. Also, in the recent earnings release, the company yet again lowered its selling, general and administration (SG&A) guidance by $4 million to $118-$124 million for 2014.
Despite the tough industry conditions, the company's liquidity position stays strong and supportive. The company ended the second quarter of 2014 with a total liquidity of $1.25 billion, including $ 1 billion of cash, registering a cash burn of $120 million in the quarter. ACI's cost control efforts will help it preserve cash to survive the industry downturn. Also, ACI lowered its 2014 CAPEX range to $170-$180 million from $180-190 million and reduced its depreciation, depletion and amortization (DD&A) to $410-$430 million from $420-$450 million for 2014.
Moreover, the company has done well to extend its debt maturities, and it has no long term debt maturities until 2018, which will help ACI navigate through the tough industry conditions. UBS analyst, Kuni Chen, believes the company has enough liquidity to survive for the next three years in the prevailing tough business conditions.
The Coal Industry is going through difficult industry conditions, and ACI is no exception. ACI has been taking the right steps to survive the difficult industry conditions by preserving cash through cost controls and by lowering CAPEX. Also, the company does not face any long term debt maturities until 2018, which reduces its bankruptcy risk. Moreover, I believe the company has done well by lowering its high end of thermal and met coal guidance for 2014, which will help address issues of oversupplied coal markets, and will help in a coal price recovery in the long term. I believe the company will benefit from a recovery in coal prices and remains a good investment option for long term investors.
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