This Actively Traded Coal Stock Is Too Expensive

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Alpha Natural Resources Stock is Simply Not Cheap.....

I recently wrote an article, [see here] suggesting that coal stocks are fully valued and are value traps, or worse. I continue to see downside risk for the group. In my prior article I discussed how much Peabody Energy's, (NYSE: BTU) earnings estimates for 2013 have changed over the past 18 months. In this piece I discuss heavily traded Alpha Natural Resources, (NYSE: ANR), which I believe has limited upside and more likely will decline.

Investors are drawn to Alpha as well as Arch Coal, (NYSE: ACI) and Walter Energy, (NYSE: WLT), because the stock prices of these companies have plunged along with the underlying coal market fundamentals. Alpha, Arch, Walter and Peabody are down 60%, 56%, 51% and 35%, respectively from their 52-week highs. In fact, the carnage has been even worse than that. These four are down between 65% and 85% from their peaks in 2011!

The Amazing Coal Price Market of 2011 May Never be Seen Again!

2011 was a banner year for coal companies, but one that will not be repeated anytime soon, if ever. Fooled by the tremendous strength in the coal markets, each of these companies made significant debt-financed acquisitions at the very top of the market. For example, Alpha paid top dollar for troubled Massey Energy and subsequently closed a meaningful amount of legacy Massey mines. At the time of the deal, the combined Enterprise Value, "EV," [Market Cap + Debt - Cash] was about $15 billion.

Today Alpha's EV is $4.5 billion, of which $3 billion is debt. Alpha was not alone in grossly over-paying for acquisitions. Arch acquired International Coal and is saddled with $4.6 billion of debt on an EV is $5.5 billion. Not to be outdone, Peabody acquired Australian producer Macarthur Coal. This deal may never live up to expectations as Macarthur produces a type of coking coal called PCI that has suffered greatly. A rebound in PCI prices to levels anywhere near those of 2011 is unlikely. Still, Walter's acquisition of Canada's Western Coal could turn out to be the worst of the bunch. This high-cost operation remains challenged. Without a return to elevated coking coal prices, the legacy Western Coal assets will on be worth a small fraction of what Walter paid.

I'm not picking on Alpha when I say that most coal stocks are fully valued. I chose Alpha because it's an actively traded coal stock that's considered by some to have spectacular upside. The highest price targets are $15 and $16 per share, 60%-70% above the current price of $9.40. I don't see upside of that magnitude as realistic. Alpha is already trading at a 10x multiple of its expected 2013 Earnings Before Interest, Taxes, Depreciation & Amortization, "EBITDA." As stated earlier, Alpha's EV is $4.5 billion, compared to an expected $450 million of EBITDA this year.

Price Targets of $15-$16 for Alpha are Too High

If Alpha were to trade to $16 per share, the EV would be $6.5 billion and the EV / EBITDA ratio would climb above 14x. There are many, many strong stocks in the market that trade with forward EV / EBITDA ratios of 5x-6x. Alpha only appears cheap because it has fallen so far. Investors buying Alpha at $9.60 are either assuming that 2013 earnings will come in well above consensus or that 2014 will be a much, much better year. Neither of those assumptions are good bets. Alpha's stock has moved up nicely from its 52-week low, but substantial gains from here are a long shot.

Alpha is a bull market stock tied very closely to coking coal prices. Unlike annual contracts for thermal coal, used to generate electricity, benchmark coking coal prices are largely settled quarterly. Therefore, Alpha can not fall back on previous higher-priced contracts. Instead, Alpha is stuck with very depressed prices, down exactly 50% from mid-2011 at $165 per metric tonne. This benchmark price is for the first quarter of 2013, meaning that prices would have to rise substantially in the 2nd half of 2013 to make up a terrible 1st half.    

Don't Pay More Than $8 per Share for Alpha

Here's my math. Assume that in 2Q 2013, coking coal prices increase to $185 per tonne from the current $165. That's generous as spot prices remain at or below $165 per tonne. With a $185 settlement for 2Q, the average for 1H 2013 would be $175 per tonne. In order for Alpha to thrive and warrant a EV / EBITDA multiple well above 5x-6x, coking coal prices would half to average $250 in 2H 2013. That would mean for the entire year prices would have averaged $212.50 per tonne. This is what I believe Alpha needs to be a $15-$16 stock in the next 6-12 months.  This is a low probability scenario. I would wait for Alpha to fall below $8 per share before considering a long position.

The only coal producer worthy of a look is Alliance Resource Partners, (NASDAQ: ARLP). Alliance is trading at half the multiple as Alpha yet has far better prospects and a solid balance sheet. I've written several articles on Alliance in recent months, [see here and here ]. 

MockingJay2011 owns shares of Alliance Resource Partners. The Motley Fool recommends Alliance Resource Partners, L.P.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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