"ANR is 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 ANR is that it has good balance sheet strength including $1.8b of liquidity." - Peter Epstein, 25 Jun 2012
We are long ANR.
ANR has strategically positioned itself to restructure in the current downturn, and is in the best position of the coal stocks to rebound. ANR's going-forward operational leverage is huge.
The key number is operating margin difference between current "bellweather" BTU (20%) and ANR (6%). We believe ANR will close that gap and become as profitable from an operational point of view as BTU.
14% operating margin increase on ANR's current $7.8b of revenue = $1.092b, which is $4.90 per share of additional cash flow that ANR will bring to the table. Many moves to increase operating margin are already in place.
D. E. Shaw has upped their ANR shareholdings from 31 Mar 2012; they own approximately 8m shares now, and are one of the smartest money managers.
For background, please see Seeking Alpha author Peter Epstein's June 20, 2012 article ranking of eight coal companies (BTU, CNX, ACI, PCX, ANR, WLT, CLD and JRCC).
Link to Mr. Epstein's article is: seekingalpha.com/article/672071-coal-sto...
Only four companies, ANR, BTU, CNX, and WLT, achieved Mr. Epstein's 4.0 highest ranking. We've also considered ACI given its position in the industry.
We believe ANR will improve operating margins:
A key number is difference between operating margin figure between BTU and ANR (20% versus 6% as of 2Q 2012).
We believe that ANR will improve to match BTU's 20% operating margin, and become as profitable from an operational point of view as BTU. When you cut expenses, they initially go up as you pay people off. So right now seeing extra expenses for severances etc.
14% operating margin increase on current $7.8b of revenue = $1.092b, which is $4.90 per share of additional cash flow that ANR will bring to the table. Done with this by end of 2013. Market will price it in a year early, by Jun / Jul 2013.
That $1.092b additional cash flow will start showing up where it's obvious in the balance sheet in 2014. ANR has stated they have already achieved $150m of their $220m to $260m of stated synergies just in general administrative and operating expenses as of 30 Jun 2012, but they are not reflected in 2Q numbers
Thus, 1/4 of $150m, or $37.5m, will be seen in upcoming 3Q report.
ANR's 30 Jun 2012 report also noted they anticipated non-cash reduction by $80m per year. That's another $20m per quarter that they'll reduce.
Adding these together, we already know that this 3Q ANR will have $57.5m less in expenses. ANR has told us this, but ANR's materials to date haven't connected these dots.
After all the write-downs and one-time expenses, ANR had $72m loss, or $.33 per share in the second quarter. That $57.5m is included in the $72m in the second quarter, but won't be included in the third quarter.
If nothing else changes, 3Q loss will be $72m - $37.5 - $20m = $14.5m in our opinion.
Street is expecting $.44 cent loss = $80m. We think it will be $15m, not $80m.
Upside in 2013 and 2014:
No gross margin expansion opportunities at the other four competing coal stocks (ACI, BTU, CNX, and WLT), whereas there are at ANR.
ANR lost $72m in 2Q, or $0.33 per share, times four = running at negative $288m annual rate.
$1.092 = gross margin increasing by 14% on $7.8b of revenue.
So if you take the $288m plus the $1.092b they will save, they could make $806m pre-tax cash flow going forward. Positive swing. On $220m shares, that's $3.90 per share in cash flow.
Please reference Coal Industry Analysis spreadsheet, uploaded to Mediafire on 18 Jul 2012
Cell F6 shows that ANR's Total Market Cap / Adjusted Equity was at 33% at end of 2Q.
Going from -$288m to positive $806m, supports taking ANR's stock price from 33% to 100%, in other words, a stock price of approximately $20.
That's what will show up going into 2014, even without any volume increases.
However ANR is laying groundwork internationally so that, when coal becomes needed around the world again, ANR can increase its production by 25% to 30% across the board. So revenue will go up by a further $2b.
ANR's current volume is down to 80% of pre-merger ANR + Massey volume because of low market prices. So when the coal market turns around, they will make up that 20% of volume or more.
90% of that 20% volume is variable cost dollars. SG&A will be relatively stable, because fixed costs are already covered. So ANR could almost double its projected $806m of cash flow - a very big deal.
Pre-merger, Massey + ANR two years ago cash flowed at $2.4b.
Further, consider as a model the Patterson Energy stock buyback - exactly what ANR will do. Any buyback would be accretive at anywhere under $21 / share, because book value is $21.
ANR is cutting costs:
ANR is only one of five in its competitor grouping that has long to do list of ways to improve its gross margins. Competitors don't have acquisitions to assimilate, mines to sell, synergies to improve etc.
Current coal industry downturn provides ANR with an opportunity / "cover" to accelerate cost cutting. More employees per revenue level versus all four competitors, which offers opportunity to reduce. ANR cut 1,200 employees in Sep 2012 re-org. We predicted that in writing prior to ANR's announcement.
Synergies between Massey and ANR operations: $150m already achieved by mid-year 2012. Coal industry downturn helps ANR accelerate its synergies.
ANR's 2Q cost of coal sales in the east were $74.21 / ton compared to $70.88 a year ago, and down nearly $2 from $76 in the prior quarter.
Reduction of ANR's coal inventory.
Final annual installment payment for Eco-Butte lease by application in the Powder River Basin, so another cost off the books.
ANR is strengthening its balance sheet:
Balance sheet comparisons to competitors will look great going forward. ANR will start creating shareholder loyalty. Ultimately may do another acquisition.
$2.4b write-off (announced 3 Aug 2012), in addition to the $753m goodwill write off in last quarter of 2011. We predicted 3 Aug write off in writing three weeks earlier prior to it occurring.
ANR now has $3.35b in long-term debt. ANR's annual interest rate is approximately $195m on this long-term debt, so effective interest rate is 5.9%, even counting the 9.75% ANR paid for its $500m it raised Sep 2012.
ANR's effective interest rate is much lower than ACI's effective interest rate. ACI has 40% more debt, and only 50% of ANR's revenue.
Raised $500m of unsecured 9.75% debt (due2018) right after ANR announced their Strategic Repositioning Plan (including 1,200 layoffs) on 18 Sep 2012, and repurchase of 3.25% debt due in 2015. This allows ANR to refinance debt due in 2015 and extend it by three years.
Small amount of $500m raised allows ANR to test the market and pull together their documentation. Very smart, AIG did the exact same thing.
Credit agreement amendment in Jun 2012.
Paid off $200m of legal expenses in Jun 2012. Last of the major expenses from Massey acquisition.
Potential to spin off certain mines. BTU did this five years ago where they spun off Patriot and gave Patriot $2b of pensions. ANR very smart to use equity in Massey. Ability to sell off assets in individual mines.
Of other four in the group (ACI, ANR, CNX, BTU and WLT), ANR is only one right now not paying a dividend, and Arch is losing money on paying a dividend. Arch would have broken even in 3Q if it hadn't had a one-time settlement.
Net operating loss carryforward has gone up - ANR will not pay taxes for several more years.
2Q SG&A was $46m. However, with one-time expenses ($5m of merger expenses, $2m of bad debt expenses) the $46m was really $39m. But, ANR had benefit of adjustment… one time thing, $15m benefit. So really at $54m of SG&A in 2Q 2012.
A year earlier in 2Q they had $190m of SG&A, minus the $125m one time fees for closing Massey, so they had $65m SG&A for 2011. So taken their annual SG&A expenses - taking out all one time items, down $11m ($65m - $54m). Separately, ANR has achieved $150m of costs of the $220m of annual synergies already behind them as of 2Q.
So we predict that ANR's cash on the books, at the end of this quarter, to be announced Friday, is $880m. Increased by $380m from 30 Jun 2012 to 30 Sep 2012.
Even if ANR only breaks even with free cash flow in 3Q (we predict it will be higher), ANR's cash balance of $500m on hand, plus $500m raised in debt, minus $120m of debt buybacks = $880m cash on balance sheet.
ANR is implementing operational improvements:
Legacy operations: ANR's overall incident rate improved. During 2Q 2012 ANR's overall incident rate improved 13% compared to 1Q 2012, and legacy Massey operations improved 9% from the previous quarter and a remarkable 39% since 3Q 2011 (first full quarter following acquisition of Massey).
PPOV of last Massey mine that had a safety negative award - got removed in 1Q 2012. So only took 9 months to consolidate all that in.
Moving management around - Chairman and one more recently left. Shows ability to cut. Brought new international sales head.
ANR has 95% of their coal sold under contract for remainder of year. They told us that when they released their 3 Aug 2012 report.
Building world class international thermal platform.
3 Aug 2012 report uses phrases like "Ahead of expectations" and "logistical optionality." - signaling that they are improving logistically.
ANR expects to export 4m tons of steam coal, double 2011. Overall industry is down, volume is down, and this company is using time when market is lousy anyway and all five companies' stocks are in tank, and they picked this time to clean up their problems.
They don't want to be cleaning house when coal stocks are popular. That would be a waste. They want to do it when coal stocks are in the tank, which is what they are doing. Very smart as to when they timed this.
We'll end with ANR's own words:
"We have laid a solid foundation for the future. Alpha is not merely well positioned to weather the current storm, as market conditions improve Alpha is poised to advance its leadership position in the industry. As always and perhaps more than ever we remain focused on maximizing free cash flow and creating shareholder value over the long term." - ANR's 2Q 2012 earnings call transcript.
This article is only a highlight of our internal analysis.
For further background, please reference our previous posts:
Coal Industry Analysis spreadsheet, uploaded to Mediafire on 12 Jul 2012:
Updated Coal Industry Analysis spreadsheet, uploaded to Mediafire on 18 Jul 2012:
Yahoo Finance post of 29 Jul 2012, where we recommended $2.6b further write off prior to ANR's Sep 2012 write off:
Yahoo Finance post of 5 Sep 2012 where we predicted ANR's opportunity to improve employees/revenue, prior to ANR's announcing reduction of 1,200 employees in Sep 2012 re-org:
Yahoo Finance post of 5 Sep 2012:
Disclosure: I am long ANR.