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Anyone foolish enough to venture into the coal sector looking for black gold had better pick a company that won't end up like the proverbial canary. A stock that offers compelling risk/reward is Alpha Natural Resources, (NYSE: ANR). Be warned, there are caveats. First, Alpha is a high risk / high volatility stock that's down 90% from last year's high. Frequently when a stock is down that much, the company in question is in financial distress. With Alpha, there's no imminent financial distress and the Company's product is out of favor but not going away.
On Wednesday, August 8th Alpha will report its 2nd quarter earnings. Over the past few weeks, companies including Peabody Energy, (NYSE: BTU), Arch Coal, (NYSE: ACI), Consol Energy, (NYSE: CNX) and Walter Energy, (NYSE: WLT) reported 2nd quarter earnings. To say the least, earnings season for the coal sector has been a mixed bag.
Peabody was the first to announce, and they disappointed. Peabody shares were down 18% in the 2 days following their report. Interestingly, the problem for Peabody came largely from their Australian operations where coking coal pricing was lower and costs higher than expected. Peabody announced a switch from contract mining to company-operated mines in Australia. This seemed to be a smoke-screen tactic to divert attention away from the earnings for awhile.
Arch reported a few days after Peabody, reversing the negative sentiment in the space, by showing strong cost control and speaking positively about coal inventories, natural gas prices and hot summer temperatures. Within days, Arch stock was up over 45% to an intra-day high $7.75 per share, but has since fallen back to about $7.00.
Walter offered few surprises when it reported. The company continues to perform well on the production and sales front, which is good because Walter has a history of production issues due to difficult mining conditions. Roughly 50% of Walter's coking coal is premium low-vol, 25% mid-vol and 25% PCI. This is by far the most favorable mix of any U.S. producer and enabled the company to achieve strong pricing. Walter reiterated full year guidance on costs and production. All and all, this was a well received report.
Consol Energy reported inline results, but the company's outlook was surprisingly cautious. Importantly, Consol announced that it booked some of their best low-vol coking coal at prices well below analyst expectations. This raised the question of why Consol would book the tons at all. Through Consol we learned that coking coal prices were taking another leg down, which became more widely known in the days following Consol's conference call.
Alpha produces both thermal and coking coal. Investors are punishing Alpha for its thermal coal exposure in Central Appalachia, "CAPP." However, CAPP prices have rebounded modestly even as coking coal prices have fallen. While the volatile coal prices play out this year and next, Alpha's earnings will suffer. In 2012, Alpha's EBITDA will likely fall by a third. Next year's EBITDA is forecast to be half that of 2011's. Yet Alpha is not in immediate financial jeopardy. Alpha's management negotiated debt amendments, giving them ample flexibility through the end of 2014.
Alpha last reported $700 million of cash and $1.1 billion of undrawn bank facilities, for total liquidity of $1.8 billion. Net debt to trailing 12-month EBITDA was about 2x, a very favorable level. Even if EBITDA is cut in half compared to 2011, leverage would remain below 5x. With no possible debt triggers before 2015, Alpha has the staying power to come out of the coal market downturn in very good shape.
As bad as the coal market is, there's light at the end of the coal shaft. Next year coal prices should be a lot better than today's spot prices. In the meantime, coal companies are cutting production like crazy to balance supply and demand. With China growth fears, an anemic U.S. economy and Europe possiblly in recession, demand for coking coal is weak. Prices for benchmark high quality coking coal have fallen from $330 per metric tonne to about $200.
Coking coal prices are much more cyclical than thermal coal prices. Coking coal prices are supported by marginal costs thought to be between $175-$185 per tonne. So, it appears likely that both coking and thermal coal prices are near a bottom. Post 2nd quarter earnings, most of the bad news may be out. Alpha is poised to be a long-term winner when coal prices rebound. The Company is the largest coking coal producer and exporter in the U.S. and it has 25-30 million tons of export capacity. Importantly, about 2/3's of Alpha's coking coal is high margin top-tier quality.
A year ago, the consensus EBITDA estimate for 2013 was a whopping $2.4 billion. At that time, natural gas prices were near $4 per MCF and top-tier coking coal was comfortably above $300 per tonne. Last year Alpha generated $1.2 billion in EBITDA. As mentioned earlier, EBITDA could fall by as much as half to $600 million next year, but as coal prices recover, EBITDA should reach $1 billion again in 2014 or 2015 and as much as $1.5 billion in strong years. While patience and a strong stomach is required, investing in down and out coal stocks like Alpha offers a compelling risk / reward opportunity that should be considered by long-term holders.
MockingJay2011 owns shares of Alpha Natural Resources, Walter Industries, and CONSOL Energy. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.