Coal demand has been squeezed since the sharp decline of natural gas prices. This decline in demand has caused a severe decline in prices, resulting in declining profitability for coal companies over the last two years or so. To make the situation worse, even the global demand for met coal is declining (due to a declining demand for steel). This has created a tough time for coal players with large met coal exposure that had been somewhat immune to local declining coal demand.
In these dire circumstances, the only question to be asked is: Is there any coal company that we can invest in?
Which coal company to invest?
While Arch Coal Inc (NYSE:ACI) demonstrated solid unit cost performance during the first quarter (-7% on a sequential basis), the overriding issue for Arch Coal (and for the group) continues to be weak pricing, most recently in the international met & thermal coal markets.
For Arch Coal Inc (NYSE:ACI), the issue of weak pricing is compounded by massive changes in the Balance Sheet in the past two years, leaving little equity value unless prices improve significantly.
Currently, Arch Coal Inc (NYSE:ACI) has over $4 billion of net debt, vs. $1.5 billion as of the first quarter of 2011. The company also has a share count that is 30% higher now than it was in the first quarter of 2011. Meanwhile, the Street estimates the company’s earnings before interest, taxes, depreciation and amortization for 2013 to be $445 million (and $540 million in 2014), which is way lower than its 2010 annual EBITDA as it was closer to $900 million.
As a result, even though the share price has collapsed from $35 to $5 over the past two years, Arch is still trading at 11.5 times its current year EBITDA (and 9.8 times its estimated 2014 EBITDA), whereas two years ago Arch Coal Inc (NYSE:ACI) was trading at 8.0 times its then-current EBITDA.
It is important to understand that this is not a liquidity/cash burn issue (Arch has approximately $1.3 billion of liquidity and is only burning around $120 million of cash in 2013), but is instead a leverage issue.
There needs to be a clearer path to at least $850 million of EBITDA generation for the company’s shares to have an interesting outlook at current levels. $850 million of EBITDA is needed to bring Arch Coal Inc (NYSE:ACI)’s EV/EBITDA multiple below 6.0 times given the company’s current capital structure.
Unfortunately, the met & thermal coal price assumptions needed to attain that level of EBITDA generation are too optimistic with the current underlying thermal & met coal supply/demand drivers.