Massey Energy’s Interest in International Coal Highlights Synergies, Raises Questions on Management

63.19
Trefis
MEE: Massey Energy logo
MEE
Massey Energy

Massey Energy (NYSE:MEE) is the 4th largest coal company in the United States and the largest in Central Appalachia based on produced coal revenue.  Massey has a total of around 2.3 billion tons of high quality coal reserves. The size and quality of its coal reserves enable it to provide top quality products to wide range of customers including thermal coal for power generating utilities, custom blend industrial coal for industrial customers, and high quality metallurgical coal for use in the production of steel. It competes with Peabody Energy (NYSE:BTU), Arch Coal (NYSE:ACI) and CONSOL (NYSE:CNX) Energy.

The Produced Coal segment constitutes around 84% of the $46.98 Trefis price estimate for Massey Energy’s stock.

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Massey Considering a Bid For International Coal Group

Rumors surfaced over the summer that Massey was in negotiations for a potential take over of International Coal Group (NYSE:ICO). Departing Massey CEO Don Blankenship confirmed that the company is exploring strategic alternatives as of mid-December leading to renewed interest among investors about the implications of a tie up between the two. International Coal Group, also a leading producer of coal in Northern and Central Appalachia, controls 1 billion tons of high-quality coal reserves that are primarily high-BTU, low-sulfur steam and metallurgical quality coal.

One of Massey’s main competitive advantages is that it is the largest coal producer in the Central Appalachia region, which is a source of low cost proven reserves. Massey controls around one-third of the reserves in that region. Hence, it is expected to have cost advantages over other producers in the log-run as other producers will have to move to higher cost reserves. If Massey and International Coal merged, this could lead to synergies make the combined entity more competitive going forward.

Massey can derive significant benefits from International Coal’s mining operations and reserves, which are strategically located to serve its client base which is similar to Massey’s – utility, metallurgical and industrial customers throughout the Eastern United States.

One potential roadblock is that International Coal’s CEO, Ben Hatfield, who was a longtime Massey executive and Massey’s COO when he left in late 2001 could be opposed to a deal as reported by Bloomberg. [1]

Massey Gains From Recovery in Profit Margins and Synergies

With the increasing global demand for coal, Massey will have to scale up operations in order to remain competitive. We believe that the acquisition of International Coal Group can provide Massey with operational synergies, in addition to increasing its production capacity.

The Produced Coal EBITDA Margin increased from around 13% in 2006 to 22% in 2008, with increasing global demand for coal resulting in higher profit margins for coal producers like Massey. However, with the global economic downturn leading to a fall in economic activity across the world, profit margins fell to around 16% in 2009. As the economy recovers, we expect profit margins to rise to around 18% by 2013 and stay about flat thereafter.

However, if the company is able to take advantage of economies of scale and with the potential takeover of International Coal Group’s operations, it could realize significant synergies, which could provide an upside to our current forecast. If the Produced Coal EBITDA Margins can regain its recent highs of 22% by the end of the forecast period, it would translate to around 12% upside to our current price estimate for Massey Energy.

See our full estimates for Massey here.

Notes:
  1. Massey Said to Consider Takeover of International Coal []