Bottom In Coal Stocks?

Includes: ARCH, KOL
by: Bidness Etc

Last week, Arch Coal Inc. (ACI) reported its third quarter results, which were better than expected. The stock was up 10% on the earnings release. Strong results for the company were driven by better demand and cost control efforts. ACI's results for the quarter are being viewed as a positive sign for the industry.

Arch Coal Inc. is the second largest domestic coal producer and one of the world's largest coal producers. It sold more than 156 million tons of coal in 2011. Last week, the company reported its third quarter 2012 results, which were better than what the market and analysts were anticipating. Reported revenues for the quarter were $1.09 billion, down 9% YOY, beating analysts' revenue expectations of $1 billion. Reported net income for the quarter was $45.8 million or 22 cents per share as compared to $8.9 million or 4 cents per share in the third quarter of 2011. The company was able to beat earnings estimates as analysts were expecting a loss of 16 cents per share. In 3Q 2012, EBITDA increased to $257 million, up 21% YOY. Better than expected results for the company in 3Q 2012 were mainly driven by cost control efforts, rising natural gas prices and favorable weather, leading to better domestic thermal coal demand.

In the recent third quarter, the company shipped 37.5 million tons of coal, which was 6% less than shipments in 3Q 2011. However, if we compare it with coal shipments for 2Q 2012, it was up 19%, which is certainly a healthy sign for the company. Due to better cost control measures, operating margin per ton improved from $1.87 in 2Q 2012 to $2.07 in 3Q 2012. Operating income margin for the company improved in the quarter to 12.5%, from 6.3% in 3Q 2011.

As of September 30, the company had $650 million worth of funds on its balance sheet, out of which $551 million comprised of cash. The liquidity position of the company is further enhanced by revolving credit facility and short-term borrowing, totaling $350 million; coupled with no significant debt maturities by the end of 2015, it makes a strong case for the company's liquidity position. The company offers a dividend yield of 1.5%, and it has a strong operating cash flow yield of more than 30%.

The company has been evaluating its capital needs according to market conditions. In 2012, capital spending is expected to be in the range of $410 - $430 million, and for 2013, it is expected to be around $350 million.

Better than expected results for the company can also be taken as a sign of improvement in the coal industry, which suffered from decreases in natural gas prices in recent years. ACI and coal ETF (NYSEARCA:KOL) are both down, 44% and 22% YTD, respectively. However, there have been signs of improvement in the month of October, as ACI and KOL are up 27% and 7%, respectively. Natural gas bottomed in April to $1.91 per thousand cubic feet, which forced utilities to switch from coal to natural gas for electricity generation. Moreover, lower coal prices lead to greater coal exports by the U.S. EIA is expecting coal exports to stay strong in 2012, and reach the record level of 125 MMst.

The recent rebound in natural gas has forced power plants to shift back to coal, as natural gas is losing its competitive edge. Coal demand and prices are expected to improve as natural gas prices increase further. Price of natural gas is expected to settle in the range of $4 - $4.5 mmBtu, which will most certainly render coal the more economical option.

Going forward, we believe that the performance of the coal industry will improve due to recent developments such as rising natural gas prices. Nevertheless, there are some factors that could adversely impact the coal industry. These factors include the trend in natural gas prices and environmental regulations that could discourage the use of coal.

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

Business relationship disclosure: The article has been written by Qineqt's Basic Materials Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.