Alpha Natural Resources Worth $24 Despite Mixed Earnings Expectations

Alpha Natural Resources (NYSE:ANR) plans to release its earnings for Q1 on Thursday. The present oversupply of natural gas and corresponding drop in gas prices has been cannibalizing much of the demand for coal. Moreover, during this quarter, subdued overall electricity demand in the U.S. has caused utility companies to reduce their coal consumption.  However, demand for metallurgical coal has been better and should help support earnings.

Alpha Natural Resources operates in the production, purchase, sale and resale of industrial and metallurgical coal and also provides freight and handling services to its coal customers. Alpha competes with other coal producers like Arch Coal (NYSE:ACI), Peabody Energy (NYSE:BTU) and CONSOL Energy (NYSE:CNX).

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Subdued Domestic Demand From Utility Companies in Q1

Due to the warmer winter season in the U.S., electricity consumption has declined  which will impact the company’s earnings. As nearly 40% of electricity in the U.S. is generated by burning coal, coal demand was low in Q1.

On the other hand, natural gas is cheaper and more environmentally-friendly than coal, and the retirement of a number of coal-fired power plants is causing a decline in overall coal consumption in power generation. The U.S. Energy Information Administration, however, has estimated that domestic coal production will increase at an average rate of 0.3% though 2035, ^[1] but we still expect utility coal shipments to decline in the quarter. Other than domestic demand, Alpha Natural is positioning itself well to meet the international coal demand from emerging markets through exports, where it can get better prices for its coal.

Metallurgical Coal, Emerging Markets Driving Growth

Even though U.S. coal demand has been weak, emerging markets form a major source of demand for coal companies in the U.S. In the future, as U.S. export terminals increase capacity, the outlook for coal companies should improve significantly.

We recently updated our forecasts for Alpha Natural. We removed the company’s purchased coal section and incorporated those sales in the metallurgical coal or utility & industrial coal segments. Our forecasts for metallurgical coal prices have been raised because of the expectation of an increase in demand for coking coal in future, especially from emerging markets. Conversely our forecasts for utility & industrial coal have been reduced because of a visible shift towards cheaper natural gas as a preferred fuel for power generation, while our freight and handling revenue forecasts have been increased to reflect current and expected market dynamics.

We have reduced our forecasts for both utility coal margins and metallurgic coal margins as a result of our expectation that mining expenses will increase going forward. Lastly, we have increased our forecast for capital expenditures to more accurately reflect the company’s future capital plans.

Our new price estimate for ANR is $24 for ANR, which is more than 50% above the current market price, largely because of its sound outlook for long-term metallurgical coal demand.

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1. AEO2012 Early Release Overview, EIA.gov, Jan 2012 [↩]