Alpha Natural Resources Earnings Will Show King Coal’s Struggles

Alpha Natural Resources (NYSE:ANR) will report its earnings for Q2, 2012 on August 8 and we expect results to be severely affected as the coal consumption has significantly declined in the U.S. over last few quarters. Alpha’s stock price took a beating in 2012 declining nearly 70% since the onset of the year.

The market is overtly bearish over coal stocks as the fate of U.S. coal is highly uncertain at the moment. We, however, believe that the dismal stock performance is due to the transition in coal market from domestic to export. The coal companies are presently grappling to switch from domestic market to export markets as there are not enough export facilities available across the U.S.. However, export activities are gradually gearing up and soon coal companies will have enough port space for sea-borne coal trade. Alpha has recently appointed industry veteran John W. Hanekamp as Senior Vice President of International Thermal Sales and Trading to focus on expanding its thermal coal export activities. ^[1]

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Coal’s share of power generation in U.S. is dropping as natural gas is comfortably stealing share of its market. As a result, coal demand declined leading many coal mines to cease production. Recently, ANR closed two mines and scaled back production in two other mines in West Virginia. ^[2] Earlier in February Alpha announced to reduce thermal coal production by 2.5 million tons and met coal production by 1.5 million tons from its Central Appalachia operation. ^[3] On the other hand, metallurgical coal isn’t having an easy ride either. Price and demand of met coal, the primary form of export coal, also waned last year due to slow down in Chinese demand.

While we expect top line results for Q2 are expected to be disappointing, margins are equally likely to suffer due to increased spending to meet regulations and idling of mines.

Outlook

Though demand for both metallurgical and thermal coal is under pressure, metallurgical market has the ability to reverse quickly. On the contrary, revival in the domestic steam coal is likely to stretch further into 2013. The coal-to-gas switching has expanded from the East into areas served by Powder River Basin coals, which could hurt Alpha materially. Presently, it is adjusting production volumes and idling high cost mines in response to the challenging market conditions to create a sustainable thermal coal portfolio to meet the expected demand in the future.

There are two possible scenarios with long-term coal demand: Coal could regain its domestic market or it could align completely for export markets. In the first scenario, coal will compete with natural gas with periodic cyclicality. However, it’s growth hence forth will be slow due to restrictions imposed by the U.S. Environmental Protection Agency. In the second scenario, coal demand in the U.S. will disappear entirely and U.S. coal will be completely streamlined for export demand. The coal exports from the U.S. have been upbeat of late. As per EIA’s report, U.S. exported 31% more coal in 2011 compared to 2010, with exports reaching 107 million ton in 2011. ^[4] The miners are, however, increasingly searching for an equitable mix of export and domestic coal demand.

Exports could help Alpha survive

Alpha has significant operations near the East Coast. It has mines in Virginia, West Virginia, Kentucky, Pennsylvania and Wyoming, which are at considerable proximity to the East Coast. The East Coast and the Gulf Coast are ramping up construction activities of port and terminals to support growth in exports in the future. Alpha has acquired sizable port capacity along the U.S. East coast and is also entering into long term contracts with shippers in the Gulf coast.

The continued growth in Asian steel production, and gradual economic recovery in Europe will support the export coal demand. The scenario in Europe is particularly different. Natural gas sales fell in Europe, while coal demand surged due to declining coal prices there. ^[5] Europe has witnessed gas-to-coal switching and as a result coal exports to Europe rose staggering 49% in Q1, 2012. ^[6] Europe gets the majority of the coal exported from the U.S. and hence, the factors impacting European coal consumption has utmost importance to Alpha.

We believe the stock is presently battered due to market conditions and uncertain climate over coal’s future. However, we expect it to revive after the coal markets stabilize, which could take over a year’s time. A reviving Asian market and a surge in European demand bodes well with the miner’s prospects and could contribute immensely to the company’s value. However, Alpha will need to play carefully as there is stiff competition in the sea-borne coal trade with myriad players from Australia, Indonesia, South Africa and Colombia.

We are in the process of revising our forecasts for Alpha, which stands at $20.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Alpha Natural Resources Appoints Industry Veteran Hanekamp To Global Coal Sales and Trading Position, Press Release, July 31, 2012 [↩]
2. US’ Alpha Natural Resources closes two West Virginia coal mines, platts.com, 27 June, 2012 [↩]
3. Alpha Natural Resources Adjusts Central Appalachia Coal Production, Press Release, February 3, 2012 [↩]
4. 03 July 2012 – US coal exports grew by 31% in 2011, enerdata.net [↩]
5. Buy Coal Stocks Now: Coal Exports To Europe Surge, seekingalpha.com, July 3, 2012 [↩]
6. Coal Stocks Soar — Good News from Europe, Not China!, 247wallst.com, July 3, 2012 [↩]