Arch CoalInc. stocks are off to a slow start upon to the stock exchange despiteglimmers of hope in metallurgicaland thermal coal markets.
Arch returned to the NYSE after a brief bankruptcyreorganization absence, opening at $70 per share on Oct. 5 under the symbolARCH. By Oct. 6 market open, ARCH was trading at $60.41.
In the first half of its second day back on the market, Archhas seen shares remaining mostly in the $61 to $62 range. That pricing leavesplenty of room for upside based on FBR & Co. analyst Lucas Pipes' pricetarget of $71.00.
"We believe that Arch Coal is one of the few ways toinvest in met coal inthe public markets today, and we see this exposure as a positive differentiatorfor the company," Pipes wrote in a note ahead of the emergenceannouncement.
However, Pipes is not just banking on Arch's exposure tometallurgical coal. He said utility stockpiles have declined, and thermal coalprices have shown signs of an improving thermal market. This provides Arch an opportunitywith any spare capacity it may have in the Powder River Basin and other thermalcoal operations, particularly with other producers being capital constrained.
"Arch Coal's restructuring was swift; the debt burdenwas significantly reduced,and some off-balance-sheet arrangements in logistics were eliminated,"Pipes noted.
Arch returns to the market with $363 million in debt — just7% of its pre-bankruptcy debt level — and $300 million cash. Throughreorganization, the company was able to shed nearly $5 billion in debt andreduced interest expense by $329 million.
The hope is that its unique asset base is returning to acyclical boom in the market. The company's prime assets include fivemetallurgical operations featuring the new Leer that the company touts can support"decades" of mining. It also holds a massive Powder River Basinoperation, and smaller thermal coal mines in the Powder River Basin, IllinoisBasin, Colorado and Appalachia.
Metallurgical coal'slong-awaited rebound
Recently, a Goldman Sachs report indicated that metallurgicalcoal prices, which have risen 165% since the start of the third quarter, couldcontinue to surgethrough 2018. That would be great news for a company projecting a $10/tonneimprovement in hard coking coal price that translates to $40 million to $45million in EBITDA.
Chiza Vitta, an analyst with S&P Global Ratings, said that,while there has been an obvious improvement in the market, he would not expectthe metallurgical coal benchmark to get to "M&A levels." Vittawas referencing a period in which prices shot over $300/tonne and many coalcompanies levered up balance sheets with debt to buy metallurgical coal assets,a move that contributed to many of the industry's bankruptcies.
"With the companies coming back, they are coming backhealthier," Vitta said. "They have sustainable balance sheets,they're producing at a lower level. There's kind of a rebalancing and that's agood thing."
According to an investor presentation, Arch produced about3.6 million tons of metallurgical coal in the first half of the year.
"With significant reserves and a strong pipeline ofgrowth and efficiency projects, our met platform is well-positioned forsuccess," the presentation said. "We expect to produce 7.0 to 7.5million tons in 2017 — the vast majority of which is uncommitted and exposed torising prices."
Pipes notes that, not only is Arch one of the biggest metallurgicalcoal players on the block, it also comes with a large share of high-vol Aquality coal, which is highly prized by many steelmakers.
Arch expects that the recent closures of higher-cost U.S.metallurgical coal mines are likely to be permanent or require much higherprices to justify reversal. The company expects growth in "largely captive"U.S. steel markets and niche positions in Asia.
Hope for thermal?
Pipes is among a number of industry observers alsoforecasting improvement in domestic thermal coal markets. He said risingnatural gas prices are setting up a gradual cyclical recovery in the U.S.thermal coal market.
"Arch Coal's [Powder River Basin] assets are generallyof a favorable Btu mix in the [Powder River Basin], versus its peers, and haveamong the lowest costs, especially on gradually improving demand, which betterdistributes the company's fixed costs," Pipes wrote.
Arch's Black Thunder mine is among the largest coal mines inthe nation, and Arch said the mine can "cost-competitively" ship coalinto every major power generation market in the U.S. The company expects gasprice trends will favor lower-cost coal, allowing the Powder River Basin torecapture market share in 2017.
Vitta said domestic thermal coal demand is likely to remainlimited despite improvements in natural gas prices. While he sees room forprice improvement, and "clearly, it's going to be a healthier industrythan it was before," he does not believe that will induce companies toseek capital to expand supply.
Arch bases its hopes on a consensus of assorted coal marketforecasters that puts U.S. coal production this year at 697 million tons,rising to 760 million tons next year and settling lower to between 728 milliontons to 735 million tons through 2020.
S&P Global Ratingsand S&P Global Market Intelligence are owned by S&P Global Inc.