With the stock trading at 5.9x sales and competitors trading at 0.61x-1.39x sales, American Resources Corporation (OTCPK:AREC) seems clearly very overvalued as compared to peers. In addition, the company has a large amount of debt and does not own any information on the number of proven reserves owned. With all this in mind, it seems very clear that many investors may short sell this name.
Founded in 2013, American Resources Corporation bills itself as a low-cost producer of primarily high-quality metallurgical coal.
In 2017, the company executed a share exchange agreement with Quest Energy Inc., a private company, which permitted American Resources to increase its revenue line quite a bit in 2017. After this transaction, American Resources Corporation acquired coal mining and coal processing operations in eastern Kentucky.
In total, American Resources Corporation runs four coal mining plants in Pike, Knott, and Letcher Counties, Kentucky and Wyoming County, West Virginia, Sullivan, and Greene Counties, Indiana. The image below provides further details on some of the production complexes owned by the company:
Source: Company’s Website
The company’s clients are blast furnace steel mills and coke plants as well as metallurgical coal consumers, utilities, and other industrial customers.
Investors should be expecting revenues to increase in the near future as the company commenced the commercialization of metallurgical coal from McCoy Elkhorn Mine in September 2016 and from McCoy Elkhorn Carnegie 1 Mine in March 2017. In addition, the company obtained its first commercial production from the Deane Mining Access Energy Mine in October 2017 and from the Deane Mining Razorblade Surface Mine in May 2018.
There is another great feature that should be kept in mind. As a result of the recent acquisitions, the company is the holder of 58 coal mining permits issued by Kentucky Department of Natural Resources. It means that more exploration and development efforts should be expected in the near future. If the company is successful in this regard, shareholders could benefit quite a bit.
There is a very detrimental feature that mining investors may not appreciate on this name. American Resources Corporation does not seem to own figures regarding the number of proven mineral reserves. In addition, many of the mines are still at an exploration stage. Many analysts may pass on this company as this is a key metric to assess the valuation of the company’s assets. The lines below provide further details on this matter:
With an asset/liability ratio below one, the company’s financial statements may not be appreciated by many investors. It is also not beneficial that the largest amount of assets are not current assets. In September 2018, the company reported only $0.057 million in cash with underground equipment of $9.3 million, and surface equipment of $4.5 million. The company’s lack of liquidity may worry certain investors. The image below provides the list of assets:
With $50 million in total liabilities, the most worrying issue seems to be the large amount of long-term debt outstanding. The current portion of long-term debt equals $14 million, and the non-current portion equals $5 million. There is also a reclamation liability of $20 million that the company seems to have with another mining company. It is unclear whether American Resources Corporation will need to make payments soon. The lines below provide further details on this matter and the list of liabilities:
Fantastic Revenue Growth, But Not Profitable
Growth investors should appreciate that the company has increased its revenues quite a bit in 2017. The revenue line was equal to $20.8 million, which represents a 173% y/y increase as compared to that in 2016. With that, taxes, production costs and development costs don’t make American Resources a profitable business. It is not ideal for value investors. The company reported a net loss of -$14 million, 36% less than that in 2016. The image below provides the income statement for the year 2017:
The revenue line continued to increase in 2018. In the nine months ended September 30, 2018, the company reported revenue of $23 million, 52% more than that in the nine months ended September 30, 2017. In addition, in line with the losses in 2017, the company reported a loss of $7.9 million in the nine months ended September 30, 2018. The cost of sales is the largest expense. It represents 71% of the total revenue in the nine months ended September 30, 2018. The industry is very mature, but cannot offer fat gross profit margins. The image below provides further details on this matter:
Use Of Proceeds
Most investors should not appreciate that the company intends to use some of the proceeds to finance the repayment of debt. In total, the company expects to use $2.7 million for repayment of debt and payables. The other part of the proceeds will be used to acquire equipment, future acquisition of new coal mines, for mine rehabilitation among other purposes. The image below provides further details on this matter:
Expected Capitalization And Valuation
After the IPO, the company expects to have fixed assets and coal properties worth $46 million, $0.062 million in cash and current debt, and certain payables of $2.7 million. The financial risk does not seem to diminish after the sale of equity. The reduction in the debt is not that significant, and the amount of cash outstanding is still limited. The image below provides further details on this matter:
With 18.150 million shares outstanding at $12.1, the total market capitalization equals $219 million. Adding debt of $19 million and deducting cash of $0.05 million, the enterprise value equals $237 million.
In the nine months ended September 30, 2018, the company reported revenue of $23 million, 52% more than that in the nine months ended September 30, 2017. With this in mind, assuming forward revenues of $40 million seems very reasonable. Using this figure, American Resources Corporation trades at 5.9x, which seems too expensive.
The company mentions the following competitors in its prospectus:
Ramaco, which has an enterprise value of $249 million, trades at 1.2x sales. American Resources Corporation seems very overvalued as compared to METC, which reports revenue growth of 408%. Arch Coal, Inc. (ARCH) trades at 0.61x sales with 39% gross profit margin. Unlike American Resources Corporation, which reports negative net income, ARCH reports an ROE of 10%. Warrior Met Coal (HCC) trades at 1.39x sales with 38% gross profit margin.
With competitors trading at 0.61x-1.39x sales, American Resources Corporation should not be trading at 5.9x. The company reported revenue growth, but investors should remember that a large percentage of this growth was created by the acquisitions made. American Resources Corporation should not be able to grow at a larger pace than competitors for a long time. As a result, trading at 5.9x does not seem sustainable.
Not Many Institutional Investors And Low Float
The assessment of shareholders is not that beneficial. Directors own a large amount of shares and control the company. They own more than 59% of the total amount of equity. While there are other shareholders, the number of minority shareholders is not elevated. It means that the company was not able to attract institutional investors, which is not ideal. The image below provides further details on this matter:
As a result of the equity structure, the amount of float is not expected to be very elevated. It means that the stock price volatility could be quite large, which is a serious risk that should be kept in mind. Investors could make or lose a large amount of money in a short period of time.
With no information about proven reserves and a large amount of debt, the company seems a sell. In addition, with the stock trading at 5.9x sales and competitors trading at 0.61x-1.39x sales, it seems clear that the stock is very overvalued as compared to peers. Many investors may short sell this name. Smart short sellers should do it before everyone else does.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.