Alpha Natural Resources, $8 Bucks Up or $2 Bucks Down

By Peter Epstein - August 12, 2012 | Tickers: ARLP, ANR, ACI, BTU, WLT | 0 Comments

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I've studied 15 new research reports on Alpha Natural Resources, (NYSE: ANR). The range of estimates for 2013 remains quite wide and new price targets range from about $5 to $20 per share. According to Interactive Brokers data, consensus EBITDA for 2013 is $803 million with a standard deviation of $183 million.

The chart below compares that variability in forward EBITDA estimates of peers. I divided the standard deviation by the mean EBTIDA estimate. Notice how much higher the variability is for Alpha compared to Walter Energy, (NYSE: WLT), Arch Coal, (NYSE: ACI), Peabody Energy, (NYSE: BTU) and the coal producing MLP Alliance Resource Partners, (NASDAQ: ARLP). Clearly the movement in coal prices will have a big impact on these other companies, but analysts appear less uncertain in their forecasts.

Crunching numbers with the help of a trusted sell-side analyst model, I developed simple scenarios for next year's EBITDA by varying the estimated benchmark coking coal price, the assumed # of coking coal tons sold and net debt. It's not surprising why the analyst reports are so different. Small changes in key assumptions change 2013 EBITDA a lot. The number along the top are millions of coking coal tons sold and the numbers down the side are the assumed benchmark price.

It's interesting how much upside Alpha has to small changes. A $10 move in the benchmark coking coal price is worth $3.50 per share! An incremental 1 million tons of coking coal equates to $0.90. Each $100k decline in net debt is $0.40. And, a 0.5x change in the EV/EBITDA multiple is worth $1.80. This next chart shows prospective stock prices in 2013. Note: At an assumed benchmark coking coal price of $210 or lower I assume that ANR goes into hibernation, cuts SG&A and cap-ex enough to remain roughly cash flow break-even. In that case, the chart below could represent possible stock prices in 2014.

All of the above price scenarios assume net debt of $2.2 billion, ($100 million less than 6/30/12) and a 5.5x EV/EBITDA multiple. Clearly this is a high risk stock, but for me Alpha is a Call option on 2013-2014 coking coal prices. One can see that at a coking coal price of $220 or higher, Alpha is worth a lot more than $7 per share. If one accepts my premise that Alpha's stock is a Call option and further that the expiration date is comfortably 2 years away, then the option value is highly significant for at least the next year. Therefore, I assume (for argument's sake) that there's no difference in the stock price for scenarios of $210 or $200 coking coal.

If I were to attempt the same analysis on Walter, the price scenarios would be far different. WLT is almost entirely premium hard coking coal, so it's exposure to the benchmark coking coal price would be higher than that of Alpha's. For Consol, the assumed change in coking coal prices would have considerably less impact because Consol has a meaningful natural gas business that's not tied to coal prices. Alliance is almost entirely thermal coal, so the analysis would not be applicable. Finally, Peabody Energy might fall in-line with Alpha in terms of upside to a $10 change in coking coal prices. Peabody gets half of its EBITDA from Australia where it producers hard coking coal and low-vol PCI coals.

One can come away from this analysis bullish or bearish. With next quarter's benchmark settlement looking to be $200 per metric tonne, plus or minus $10, Alpha could be in for a rough ride next year. In fact, if one is bearish on coal fundamentals or Chinese demand for commodities, then this stock is not for you. Still, given the option value in the stock I think the downside is $5 per share and the upside $15 per share. That's $2 down and $8 up. For a high risk / high return investment, that's not a bad bet to make.

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