The ongoing downturn in the Coal Industry has adversely affected Arch Coal's (ACI) performance. ACI is the most diversified coal producer in the U.S., with exposure to both thermal and met coal operations. The company's performance in 2015 is expected to remain challenging, as both thermal and met coal markets are weak. Lower natural gas prices and rail issues in the U.S. have kept the thermal coal market soft, while lower Chinese coal imports and oversupply have been weighing on met coal prices. The company has enough liquidity to survive the industry downturn until 2018, but I think the company needs to undertake aggressive cost cuts and cut its capital expenditure, which will portend well for its earnings and cash flows. Also, the company needs to undertake more production cuts in response to excess supply in the market. I believe, in 2015, the company could opt to sell some of its non-core assets despite weak coal market conditions to boost its liquidity position and strengthen its credit outlook.
Weak Coal Market Fundamentals
The coal market fundamentals are expected to remain weak in 2015. Thermal coal demand is being adversely affected by lower natural gas prices, which have promoted natural gas-fired electricity generation. Also, rail issues in the U.S. have affected coal shipments, which have kept a lid on thermal coal prices. Along with lower natural gas prices, rail issues are expected to prevail in 2015, which will keep the thermal coal market weak in the next year. However, the thermal coal market could get some support from inventory rebuilding efforts, as coal stockpiles at electricity producers have dropped by 13% year-on-year to approximately 130 million tons in December 2014.
The met coal market is also challenged by excess coal supply, and lower coal imports by emerging markets, especially China. Last week, the met coal benchmark price for 1Q15 dropped to a multi-year low of $117 per ton, down $2 per ton quarter-over-quarter. The strengthening of the U.S. Dollar has promoted global met coal producers to keep supply high, despite weak met coal prices; international coal trade is conducted in U.S. dollars. Global met coal producers like Australian coal producers, produce coal in their currencies and get paid in the stronger U.S. Dollar. In the near future, the met coal market is likely to remain weak and will put pressure on U.S. coal producers like ACI, Walter Energy (NYSE:WLT) and Alpha Natural Resources (ANR) to curtail supply to address the problem of excess supply. Also, I believe Australian and Canadian coal producers are not likely to reduce supply due to their weak currencies. In response to weak met coal market fundamentals, U.S. coal companies, including ACI, in the 4Q14 earnings call next month, could announce incremental met coal supply cuts, which could portend well for met coal prices. Incremental met coal supply cuts in a range of 5-10 million tons are required to remove the excess supply. The following chart shows the met coal price for recent quarters.
Asset Sale and Liquidity
As coal market conditions are challenging and weighing on ACI's financial performance, consistent efforts are required to cut operational costs and capital expenditures to survive the industry downturn. In 2015, the company will focus on reducing operational costs and preserve cash. Moreover, I believe that if the coal market conditions do not improve until 2H15, ACI could opt to sell some of its non-core assets despite weak asset valuation to increase its liquidity and improve its credit outlook. Also, the company could opt to redeem bonds due in 2020 (which have put a restriction on its capital structure) under its credit amendment efforts to increase capital structure flexibility.
Despite the ongoing tough industry conditions, the company has sufficient liquidity to survive the industry downturn until 2018. The company currently has total liquidity of $1.3 billion, including $1.05 billion of cash. The company expects to end 2014 with total liquidity of $1.2 billion, including $1 billion of cash. Moreover, the company does not face any near term bankruptcy risk, as it does not have any debt maturities until 2018. The following chart shows the liquidity position and debt maturity profile of the company.
Source: Company Reports
ACI's performance is likely to remain challenging in the near term, as coal market conditions are weak. The company needs to make efforts to lower operational expenses and preserve cash. Also, the company could announce incremental supply cuts during the 4Q14 earnings call next month. The company currently has a healthy liquidity position, but could undertake the sale of non-core assets to boost liquidity further. I believe that to ensure their survival in the long term, U.S. coal companies need to address the problem of excess supply in the market, which have kept a lid on a coal price recovery.
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