Would the Sale of Assets Help This Coal Stock?

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Coal stocks continue to remain under pressure this year. Falling coal prices and uncertainty about the world economy and coal demand has pushed coal stocks down. President Obama’s plan to limit coal-fired plants adds more pressure to the industry.

When the situation got dire, coal companies started to implement their cost-cutting plans. Their strategy was to limit their expenses and wait until the storm passes. However, the storm seems to be at full throttle and coal prices show no hint of going up. Now, coal companies have started to explore the next possibility – the sale of assets. 

The impact

Arch Coal (NYSE: ACI) sold its Utah operations to Bowie Resources for $435 million in cash. Arch Coal had $730 million in cash and $248 million in short-term investments at the end of the first quarter. With the addition of fresh cash, Arch Coal could potentially have more than $1.2 billion of immediate liquidity. Why is this important?

Arch Coal is losing money quarter after quarter. The company is projected to lose money this year and the next year. The company has two sources of loss. It is losing money from operations and losing money from interest expense. In the first quarter, the loss from operations was $32.4 million, while the loss from interest expense was $92.2 million.

By making this sale, Arch Coal effectively narrows its loss from operations and boosts cash.

Indebted

Debt is the most important problem for coal companies. Arch Coal has $5.1 billion of long-term debt. The first portion of this debt, worth $600 million, matures in 2016. The company still has time to get things right before the time to pay the bills would come. It’s highly unlikely that Arch Coal would be able to refinance its debt. Walter Energy, the met coal producer, recently explored options to refinance its debt. In less than two weeks after the initial announcement, the company has stated that it does not plan to do the refinancing. The rates were unacceptable.

Standard & Poor’s has recently lowered its rating on Arch Coal’s senior secured bank debt to ‘BB-‘ from ‘BB’. If we look at the rates for already issued securities, we can assume that the company would not be able to issue more debt on comfortable terms. Seniors notes due 2016 yielded 8.75%, while senior notes due 2019 yielded 9.875%.

This situation is common among peers. Peabody Energy (NYSE: BTU) has $6 billion of long-term debt. The company had $630 million in cash at the end of the first quarter. The company had operating profit of $88.8 million, which was offset by interest expense of $101.3 million. Peabody has better terms on its securities. For example, senior notes due 2016 yielded 7.375%. While Peabody is in a relatively better position, its stock is down 44% while Arch Coal is down 49%.

Alpha Natural Resources (NYSE: ANR), which is down 45% this year, has less debt. The company owes $3.3 billion in long-term debt. However, it reported a $130 million loss from operations in the first quarter. The company is projected to report losses during the next two years. Alpha Natural Resources had $610 million in cash at the end of the first quarter. The liquidity situation is still satisfactory, but the company can follow Arch Coal’s example.

Is there light at the end of the tunnel?

Peabody’s CEO Gregory Boyce has stated that he sees global coal demand rising by 1.4 billion metric tons over the next five years. Currently, global demand for coal stands at about 8 billion tons a year, so Mr. Boyce is predicting a 17.5% rise in demand. According to him, India would play a key role in the rise of the demand. While all eyes are on China and its slowdown, the Indian government has stated that it is moving to boost coal imports and electricity-generating capacity to deal with the lack of electric power.

For the coal companies to succeed, this projected rise in demand must turn into higher coal prices. There are limits to cost-cutting and they would soon be reached. The companies are selling at attractive P/Bs: Arch Coal at 0.28, Alpha Natural at 0.24, and Peabody at 0.81. The fact that Peabody makes money from its operations while losing on interest expense makes it trade at a premium to the two other stocks.

Bottom line

Whether you believe in the Indian story or not, coal stocks are a risky place to be at this moment. They are highly indebted and may be forced into selling some non-core assets. Analysts paint optimistic target prices for them. Arch Coal has a $5.68 mean target price, a 54% upside. Alpha Natural has a $9.19 target price, a 72% upside. Peabody Energy’s target is $25.79, upside of 74%. However, things can easily get worse before they get better.

Proceed with caution.

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