Litmus Test For Coal Producers, Alpha Slashes Production
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Large Production Cuts at Alpha
On Sept. 18, coal producer Alpha Natural Resources, (NYSE: ANR) announced a major curtailment of production. While not a shock given market conditions, the magnitude of the cuts was a surprise to some. For months investors have wondered if there's bad news out for Alpha. I guess it can be said that we are closer than we were before. However, a difference this time around is that Alpha's stock did not test its recent low. In fact at $7.63 per share, Alpha is still 45% above its intra-day low of $5.28 on September 5th.
I don't know if all the bad news is out or not, but the stock price suggests that some investors think the bottom is in. Even if the bottom holds, there's a lot of space between $7.63 and $5.28! Alpha has already fallen 16% from last week's intra-day high of $9.05. My hurdle rate for investing in Alpha is 30% which equates to a target price of ~$10 per share. Unfortunately, I feel the chance of Alpha reaching $10 or more over the next 6 months is 50% at best.
Alpha's Cuts a Litmus Test for the Coal Sector, 12 Analysts Weigh in
Alpha's strategic cuts can be viewed as a litmus test for the coal sector. With 12 analyst updates in 2 days, the consensus on Alpha has moved closer to reality and the analyst changes are a sign of things to come for peers including Walter Energy (NYSE: WLT), Arch Coal (NYSE: ACI), Peabody Energy (NYSE: BTU) and Consol Energy (NYSE: CNX). In looking at the analyst updates, it seems that they did not go far enough in cutting 2013 estimates. Next year's average Earnings Before Interest, Taxes, Depreciation & Amortization, (EBITDA) from the 12 reports I read is about $600 million. However, included in this new average are 3 estimates that remain above $800 million.
Further evidence that next year's estimates are too high comes from Standard & Poors who put Alpha's bond ratings on negative watch. S&P stated on September 19th that they now believe EBITDA will be "materially lower" than their prior estimate of $800 million. S&P gives a clue as to what they think it will be by stating that next year's debt to EBITDA ratio will likely be 6x. This implies EBITDA below $600 million. Among the analyst updates are a few EBITDA targets in the $350-$500 million range.
Are Investors This Week Betting on a 2013 Recovery?
Investors buying Alpha or peer coal producers probably think that they're betting on a 2013 rebound. However, coal fundamentals remain so weak that I fear 2013 is shot and only in 2014 is a significant rebound possible. This does not mean that long-term investors are foolish to be buying coal stocks this week. But I do believe there will be better buying opportunities in weeks to come. To reiterate, I'm not calling for 2012 lows to be tested, but Alpha (as a proxy for the sector) could fall below $6 per share and still be comfortably above its low tick.
Arch is especially vulnerable due to its high debt level of $4.5 billion. Arch took on a big chunk of debt to acquire Intl. Coal last year. Elevated interest expense and planned capital expenditures over the next 2-3 years leaves little room for debt repayment. Debt to EBITDA for Arch could climb to 10x or more, a truly alarming level. While I'm long Walter Energy through March, 2013 call options, my bet is looking increasingly grim. I have been a big believer that prices for top-quality coking coals would hold up much better than lesser quality coking coals. This has not been the case as the prices of ALL qualities of coking coal have crashed.
Consol is interesting in that it is exposed to both coal and natural gas. But, the September-October period is frequently weak for natural gas pricing. Consol has executed well in the Marcellus and Utica shale plays, but that may already be reflected in Consol's share price which is down far less than peers.
Risk is to the Downside, Avoid the Coal Stocks For Now
Spot prices for premium hard coking coal, the best in the world, are at $140 per metric tonne. That's a far cry from last week's announced benchmark settlement at $170 per tonne. I'm on record as saying that U.S. coking coal producers need a minimum of $200 per tonne benchmark pricing to make respectable earnings. Unless there's a supply disruption, it will take at least 2 quarters, and probably 3, for benchmark coking coal prices to return to $200 per tonne.
I paint a dire picture, but not one that's at all difficult to imagine given where things stand today. A bet that all the bad news is out in the coal sector does not ensure that coal equities will bounce meaningfully anytime soon. Therefore it's best to stay away for now.
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.
