Arch Coal: A High Risk, High Reward Play In The Coal Space

Feb.21.12 | About: Arch Coal (ACIIQ)

Coal stocks have been beat up over the past year as coal prices have come down. However, this has created some nice opportunities in coal stocks and Arch Coal (ACI) may be one to take a closer look at. As with the other coal stocks, the valuation metrics suggest that the stock is undervalued. However, the drawback to Arch Coal versus the other coal stock is the company's debt load.

The company had $3.9 billion in net debt at the end of last quarter for a debt to equity ratio of 1.3. The company does have the ability to pay off the debt over time with its free cash flow, but another down draft in coal prices and the company may be in some financial difficulties and see a lower stock price. On the flipside, the upside will be greater than competitors' too because the stock is more leveraged than the others. I took a closer look at the following six items when researching the company:

Valuation: Arch Coal's trailing 5 year valuation metrics suggest that the stock is undervalued both of the metrics are below their respective 5 year averages. Arch Coal's current P/B ratio is 0.8 and it has averaged 2.4 over the past 5 years with a high of 6.3 and low of 0.9. Arch Coal's current P/S ratio is 0.7 and it has averaged 1.6 over the past 5 years with a high of 4 and low of 0.6.

Price Target: The consensus price target for the analysts who follow Arch Coal is $19. That is upside of 35% from today's stock price of $14.19 and suggests that the stock is undervalued at these levels. This also suggests that the stock has significant upside and is an attractive opportunity at these levels.

Forward Valuation: Arch Coal is currently trading at about $14 a share with analysts expecting EPS of $1.35 next year, an earnings increase of 27% y/y, for a forward P/E ratio of 10.5. Taking a look at the company's publicly traded comparisons will give us a better idea of the stock's relative valuation. Peabody Energy (BTU) is currently trading at about $36 a share with analysts expecting EPS of $4.74 next year, an earnings increase of 44% y/y, for a forward P/E ratio of 7.6.

Consol Energy (NYSE:CNX) is currently trading at about $37 a share with analysts expecting EPS of $3.2 next year, an earnings increase of 18% y/y, for a forward P/E ratio of 11.6. The mean forward P/E of Arch Coal's competitors is 9.6 which suggests that Arch Coal is fairly valued relative to its publicly traded competitors.

Earnings Estimates: Arch Coal has beat EPS estimates 1 times in the past 4 quarters. The company's EPS figures have come in between -16 cents and 4 cents from consensus estimates or about -33.3% to 12.5% from analyst estimates. The company has reported earnings that have differed from analyst estimates by a wide margin which suggests that the stock may experience upside from earnings surprises.

Top Stock Holders: The top two funds that own Arch Coal are T. Rowe Price New Era, which owns 4.4 million shares or 2.06% of the shares outstanding, and Nuveen Tradewinds Value Opportunities, which owns 4.2 million shares or 1.99% of the shares outstanding. The top two institutions that own Arch Coal are T. Rowe Price Associates, which owns 24.9 million shares or 11.77% of the shares outstanding, and Tradewinds Global Investors, which owns 13.6 million shares or 6.41% of the shares outstanding.

Price Action: Arch Coal is down 58.3% over the past year, underperforming the S&P 500, which is up 3.7%. Looking at the technicals, the stock is currently below its 50 day moving average, which sits at $14.67 and below its 200 day moving average, which sits at $19.67.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.