2013 Consensus From Last Year Proved to be a Tiny Bit High...
To say that earnings estimates for CY 2013 have come down a lot would be a gross under-statement. Based on data from Interactive Brokers, I created the following chart. The average decrease in consensus EBITDA over the past year is 50%. It's truly astonishing to see how far EBITDA estimates have fallen, or looked at another way, how high estimates had gotten. Alpha Natural Resources, (ANR), Arch Coal, (ACI), Walter Energy, (WLT) and Peabody Energy, (BTU) are representative.
Consensus for 2013 a YEAR AGO
|Consensus for 2013 TODAY|
To be clear, my goal is absolutely not to point out the shortcomings of sell-side analysts. Since these bullish estimates were made, coal producers faced an incredibly warm winter, decade-low natural gas prices, a worsening of the European economies, weaker than hoped for Chinese growth and a still anemic U.S. economy.
Still, were these seemingly outlandish EBITDA estimates so out of whack that they never could have been achieved? Or, if coal prices had held up would these estimates have been reasonable? Since last year's earnings estimates for 2013, there have been 3 important changes in the coal sector. Coal prices have come down significantly, unit costs have increased and sales volumes have fallen. Mitigating these negative impacts for some companies has been a mix shift in favor of coking coal and increased exports.
By far the biggest change in the market has been the decline in coal prices. If coal prices were to bounce back strongly, could next year's EBITDA approach the lofty levels envisioned by the aggressive estimates in the chart? No, reduced sales volume and higher unit costs would not allow for it. Instead of a banner year, 2013 is now shaping as possibly a trough-like earnings year.
Investors Need to Think About, "Normalized" Earnings Power
With all the changes in coal fundamentals, investors need to think about, "normalized earnings." While it's certainly possible that coal prices and global demand could rebound sufficiently to make 2013 a good year, it's more likely that 2014 will be the year in which investors learn the new earnings power of the coal companies. Given how far off last year's 2-yr forward estimates were for 2013, it won't be easy to forecast today's 2-yr forward estimates for 2014.
Despite the difficulty, I will try to describe a reasonable view of, "normalized earnings" for Alpha Natural Resources, which again I assume is a 2014 event. This by no means is an exact science, I'm looking for ballpark numbers. With that in mind, consider the following calculation of a normalized year for Alpha.
A Look at Alpha's Possible Normalized Earnings
65%-70% of ANR's best quality coking coal typically earns a cash margin of $40-$50 per ton. At the mid-point of 2012 guidance of 22 million tons, 65% is ~14 million tons x a $40 cash margin = $560 million. The remaining 35% of coking coals have an average margin of $15-$20 per ton, so 8 million tons x $15 = $120 million. Add $200 million from low-cost NAPP long wall operations, (10mm tons x $20 margin), and say a $1.5 margin on roughly 45 million PRB tons = $70 million. That's $950 million of cash margin dollars. Taking away $200 million in SG&A, gets Alpha to about $750 million of EBITDA, compared to $1.2 billion last year.
Notice that I made no mention of Alpha's Central Appalachia, "CAPP" thermal coal segment. That's because from speaking with the CFO of Alpha I learned that as the Company closes high-cost thermal coal mines, re-deploys equipment and focuses on export opportunities, management expects this segment's performance will not materially impact earnings. Said another way, despite fears to the contrary, CAPP thermal coal will not sink ANR.
If $750 million were the best that ANR could do, then investors would never buy the stock. Importantly, there's upside from planned organic coking coal growth to 26 - 30 million tons within 3 years. These incremental tons are skewed towards the higher quality, so ANR could be looking at 70% x 28 million = ~19.6 million tons of a $40 margin coking coal = $780 million. All else equal, EBITDA could normalize at about $970 million on an Enterprise Value, "EV" of $3.9 billion, an attractive 4.0x multiple.
Finally, and here's the key, at $250-$275 benchmark coking coal prices, (vs. ~$200 today and $330 last year) Alpha's highest quality coking coal would enjoy $60 margins like they did for much of 2011. That would be an incremental $20 x ~19.6 million tons = $390 million from Alpha's high quality coking coal alone. Therefore, due to the Company's planned organic growth, I consider Alpha to be a $1 billion EBITDA company with upside to $1.5 billion in strong coking coal years.
Reality Check on $1.0-$1.5 Billion of Normalized EBITDA
How aggressive is my $1.0-$1.5 billion normalized EBITDA estimate? Recall that in 2011 Alpha generated $1.2 billion in EBITDA, but that was aided by very strong coking coal prices. However, about a year ago the consensus estimate for 2013 EBITDA was $2.4 billion. Therefore, I think that $1.0-$1.5 billion is a reasonable number to work with.
If like me, investors can get comfortable with 2014, (and it could be 2015) EBITDA in the $1.0-$1.5 billion range, then buying the stock today at a $3.9 billion EV might be fundamentally compelling for long-term holders. The potential flaw in the analysis is that long-term holders are hard to find these days. Investors go in with the best intentions to hold long-term only to find the volatility too painful. That's why I've been buying Jan-2013 Call Options.