While coal stocks have gotten absolutely crushed, we've not yet seen bankruptcies, reorgs or distressed M&A among the public producers. Nor have we heard much about private coal company failures. However, over the next 12-24 months, we will see a lot more on this front, a shake-out with significant implications for survivors.
Who Are The Survivors?
The 8 pure-play U.S. coal producers are down 70% on average from their respective 52-week highs (see chart), and they are down 79% on average from their all-time highs. Patriot Coal, (PCX) is down 98% from its all-time high and James River, (JRCC) 96%. Alpha Natural Resources, (ANR) and Arch Coal (ACI) are down 92% and 91%!! Given this performance, nothing short of the economic viability of thermal coal as fuel for generating electricity is being questioned. I understand why the question is being asked.
Luckily, I have the answer to that question. Yes, there will be profitable production of thermal (steam) coal in the U.S. While the path to reaching a sustainable production level will be bumpy, the list of survivors is not hard to name. In determining which players will ride out this perfect storm of bad coal fundamentals, some key attributes should be considered. 1) balance sheet strength, 2) cost structure, 3) mix of thermal vs. coking coals, 4) export capability 5) regional diversification, 6) operational flexibility.
1) Balance Sheet Strength-- How much cash and borrowing capacity vs. total debt, the maturities of the debt, interest expense and maintenance cap-ex vs. free cash flow available to pay down debt.
2) Cost Structure--Cash costs per ton is of paramount importance and is compared from region to region. Sustainability of relative cost position depends on logistics, labor productivity and the quality of coal reserves.
3) Mix of Thermal vs. Coking Coal-- All else equal, coking coal is better, but high cost and/or mediocre quality coking coals may not be a savior.
4) Export Capability-- The portion of production that can be profitably exported and the sustainability of exports, most notably a company's access to or ownership of port facilities.
5) Regional Diversification-- Too much production in 1 region is risky, especially if that one region is central Appalachia! Company reserves controlled in regions not yet in production should be considered.
6) Operational Flexibility-- The rapidity and efficiency with which production can be curtailed and/or brought back online, organic growth, coal blending opportunities, equipment and labor sharing opportunities.
The following chart scores each company on a scale of 1 to 5, with 5 being the highest.
|Balance Sheet Strength||3||4||4||5||4||3||1||4|
|Thermal / Coking Mix||3||4||4||1||4||3||3||5|
Patriot Coal and James River have the lowest scores, while Peabody Energy, (NYSE:BTU), Alpha Natural Resources, Walter Energy, (NYSE:WLT) and Consol, (NYSE:CNX) have the highest. These four are clearly survivors. What about the other 4? James River and Patriot are the most likely not to survive in their current form, but I'm not suggesting that they will fail, I don't know. For example, James River has an awful lot of cash on its balance sheet.
While I don't know what will happen to James River or Patriot, I would be careful in assuming that if the coal stocks rally hard at some point in the near future, JRCC and PCX will be the prime beneficiaries. I think that role may have ceded to ANR. ANR has the best combination of upside and downside protection and may be the go-to-coal stock in the next rally. One of the most overlooked aspects of the ANR story is that it has good balance sheet strength, including $1.8 billion of liquidity.
Arch and Cloud Peak, (NYSE:CLD) come out in between the best and worst positioned companies. Cloud Peak is a survivor because it has the strongest balance sheet of the bunch. However, Cloud Peak may have trouble thriving because it's 100% exposed to the Powder River Basin and it has no coking coal. Arch appears to be middle of the road across all 6 metrics. I see little to get excited about with Arch or Cloud.
The bottom line for me is that I now like ANR the best on a risk/reward basis and I like CNX, WLT and BTU as well. I think that CNX and BTU might have trouble rallying as much as ANR on a big bounce in the sector.