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Weak market may pinch cash available for US coal's shareholder value trend

U.S. coal companies' cash holdings were down significantly in the first three quarters of 2019 compared to the year before, leaving questions about the prospects of continuing a trend of share buybacks and other capital return projects in 2020.

After a wave of bankruptcies a few years ago, many U.S. coal miners began to direct cash flow to shareholders rather than to investments in new mining projects that would risk exacerbating oversupply of the fuel. In the last few quarters, however, weak pricing overseas and a continued decline in demand for domestic U.S. coal began to eat away at some U.S. coal companies' cash holdings, an S&P Global Market Intelligence analysis shows.

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Peabody Energy Corp., the largest coal mining company in the U.S., drove the drop in overall cash holdings at U.S.-based coal companies. A Peabody spokesperson did not directly comment on the company's cash position or the market generally but noted that the company would provide a financial update with its fourth-quarter results Feb. 5.

The company's revenues and cash holdings have generally declined since the second quarter of 2018 as other top coal companies by market capitalization, such as Arch Coal Inc., Alliance Resource Partners LP and Contura Energy Inc., have kept smaller cash holdings relatively stable over the past few quarters. Arch Coal even reported a revenue increase from the start of 2019 to the end of the third quarter.

U.S. coal companies have increasingly gravitated to shareholder return programs in recent months. For example, Arch said it had returned $894.8 million to shareholders as of the end of the third quarter of 2019 since launching its capital return program in May 2017.

"I think we feel real good about the capital return program and the accomplishments that we've had so far. By design, it's been built around a model to return excess cash flows to investors, and we've continued to do that because we think an investment in our shares has been a good investment. We continue to believe that, and we plan to move the capital return program forward," Arch CFO John Drexler said during an October 2019 earnings call.

Drexler added that the company would likely moderate its share repurchases due to a decline in metallurgical coal prices and capital needs at the new Leer South metallurgical coal mine Arch is developing in West Virginia.

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In November 2019, however, Seaport Global Securities LLC analyst Mark Levin called on coal companies to "hoard cash" heading into the new year. With an upcoming election in the U.S. and the potential for demand from China to further weaken market conditions abroad, producers should "prepare for the worst," Levin wrote.

"We would encourage boards to pump the brakes on buybacks, dividends and non-essential projects. If a company has an unsustainable quarterly distribution, then cut it big. Investors will understand and may even applaud. When the situation becomes clearer, reevaluate, but for now, put the cash away," Levin wrote.

Instead, companies should focus on further deleveraging their balance sheets, Levin added.

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"Debt sinks coal companies; buybacks will long be forgotten. As debt could get a lot cheaper next November, having cash available at that point is essential," Levin wrote.

Peabody CFO Amy Schwetz recently touted the company's share repurchase program, which accelerated in the third quarter of 2019 when it repurchased $144 million of its shares. The company has reduced its share count by about 30% since it started the program, after coming back from a bankruptcy reorganization in early 2017.

"We remain committed to shareholder returns as a basic tenet of our investor appeal, understanding that modest deleveraging and reduced coal pricing moderate our near-term cash flow generation. Our balance sheet is strong, our cash level is high, liquidity has only increased since last quarter, and our reduction in liabilities has nearly matched our substantial shareholder returns in the past 10 quarters, which by themselves nearly total our entire market cap," Schwetz said on an October 2019 call.

Schwetz, who the company recently announced is taking a position at another company, added that Peabody would continue to evaluate appropriate gross leverage targets based on company-specific and industry-related factors as they head into 2020.