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How bad is the coal market? Some electrical utilities are paying coal companies *not* to ship them any more coal (negotiated deferrals). Couple that with rapidly escalating costs and heavy regulatory burdens on underground mining and a wobbly market for coking (metallurgical) coal, and Patriot Coal (PCX) is in the same leaky boat as Peabody (NYSE:BTU), Arch Coal (NYSE:ACI), and Walter (NYSE:WLT).

There's definitely value at Patriot coal - at current production levels, Patriot's reserves will outlive most of us. The relevant questions for the stock, though, revolve around whether the market can recover fast enough to forebear a difficult liquidity situation and whether the U.S. government will let miners like Patriot stay in business.

A Familiar Song From Q1

The rundown on Patriot Coal's first quarter earnings are going to ring a bell with investors who've been following the sector. Revenue fell 13% from last year as a significant drop in sales volume (tons sold down 21%) more than offset a decent increase in the per-ton pricing. Interestingly, whether it's been Arch Coal, Cloud Peak (NYSE:CLD), or Patriot, the sell-side has been pretty consistently wrong about the volume estimates (too high) and the realized prices (too low).

While pricing was up 8% per ton on average, the operating cost per ton rose 9.4% this quarter. That led EBITDA down 26% on an adjusted basis. All in all, Patriot did more or less as expected, as the miss on a per-share basis was driven by a one-time retirement expense.

How Much More Squeezing Can Patriot Take?

Patriot is presently sitting at the intersection of a lot of unfavorable trends. Although the company's Central Appalachian coal is high-quality thermal coal (high in BTU and relatively low in sulfur), there has been a mass exodus on the part of Eastern utilities away from coal and towards natural gas. If there's good news here it's that there's not much incremental natural gas generation capacity left, natural gas prices are heading higher, and a hot summer will deplete stockpiles.

The cost of doing business is a more worrisome long-term trend. New government rules and regulations have made it a lot more expensive to operate underground coal mines, and about 70% of Patriot's producible coal requires underground mining. So in addition to costlier equipment from Caterpillar (NYSE:CAT) and Joy Global (NYSE:JOY), Patriot Coal has to deal with the reality that the U.S. government would probably just as soon see underground coal mining go away.

Last and by no means least, Patriot could have some liquidity issues down the line. The company worked out new financing to deal with current debt maturity, but Patriot could be looking at a tighter squeeze in 5-10 quarters if the coal market doesn't recover. Though I don't think Patriot would find itself pushed into bankruptcy, the company may have to resort to asset sales as a stop-gap.

Still Waiting On The Met

2012 was supposed to see a recovery in the steel industry, but large steelmakers like ArcelorMittal (NYSE:MT) and U.S. Steel (NYSE:X) seemed to have missed the memo. Although Patriot's met coal is not of the highest quality, the company nevertheless does have a relatively high percentage of production coming from met coal. The company isn't quite as levered to met coal as say Walter or Alpha Natural Resources (ANR), but at over 20% I'd say it's still highly significant.

Unfortunately, Europe is doing the company no favors. About 60-70% of the company's met coal goes to Europe, and while met coal prices have been looking a little better lately, I don't know if anybody can feel really good about a story that requires a healthy Europe in the near-term.

The Bottom Line

There would seem to be little question that the value of the coal in the ground makes Patriot Coal worth more than the stock trades for today, and probably substantially more. The problem, though, is that if regulations (be it EPA, OSHA, or some other member of the government's alphabet soup) make Appalachian coal too costly to mine or burn, that value vanishes. Likewise, I'm reminded of the racing cliché that goes "to finish first, you first have to finish" - if liquidity pressures get too intense, Patriot Coal is going to have to surrender some of that value to stay in the fight.

There's a pretty shocking degree of variability on EBITDA estimates out there, even for a market as troubled and turbulent as coal. The good news, if you can call it that, is that it really doesn't matter what the 2012 EBITDA number is, because it's going to be terrible anyway. Patriot Coal would seem to be trading far below "full cycle" value or NAV, but anyone buying today has to have both a long-term outlook and a tolerance to see things get even worse before they get better.

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