Alpha Natural Resources (NYSE:ANR) reported its earnings for Q2 on August 8 and results were dismal implying the current condition of the entire coal industry in the U.S.  The only growth in revenue came from the consolidation with Massey Energy. The price and volumes of metallurgical as well as thermal coal fell substantially compared to last year. During Q2, the company was busy cutting costs as it idled high cost thermal coal and lower-quality metallurgical coal mines while simultaneously focused on higher-margin metallurgical products. It also reduced overhead expenses.
The company reported a large loss of $2.6 billion in Q2, but that was largely due to one time costs like goodwill impairment and asset impairment. At the overall EBITDA level, margins improved from 7.0% to 8.2% on y-o-y basis. We believe that in the near-term Alpha is likely to focus on increasing its metallurgical coal franchise, growing exports, and cutting costs until market conditions for coal improves.
We have recently updated our analysis for Alpha based on its Q2 earnings release and guidance provided by its management for 2012 and 2013. We have revised our price estimate for Alpha down to $9, which is still a 35% upside to the current market price.
The key changes we made to our model are decreased volumes and realizations for utility coal and metallurgical coal in the near-term, which also impacted margins. We also increased the discount rate to factor in the stock’s volatility. In its Q2 results the company also discussed reduced capital expenditure plans in 2012. Accordingly we have reduced our near-term capex forecasts for the company. Additionally, as a part of our periodical updating process, we updated the latest balance sheet items like cash and debt.
Subdued coal volumes to hurt
Alpha has coal operations in primarily three regions: Powder River Basin (Western steam coal), Illinois Basin and Appalachia (Eastern steam and coking coal).
Coal shipments from Powder River Basin (a.k.a. PRB) fell to 21.9 million tons in H1, 2012 from 23.5 million in H1, 2011, whereas its average per ton realization rose to $12.96 in Q2, 2012, compared to $11.92 in Q2, 2011. An improvement in realization could be due to higher demand for PRB coal over Appalachia coal because it’s cheaper and low on sulfur content.
Alpha owns 2 mines – Belle Ayr and Eagle Butte in PRB region with each contributing nearly 50% production of its 49.9 million ton shipments in 2011 from the region. Alpha has roughly 740 million tons of coal reserves in that region. It is believed that PRB region will serve a majority of coal export in the future as there is an uptick in thermal coal demand from Asia and Alpha would like to capitalize on this opportunity.
In the H1 2012, metallurgical coal shipments were 10.5 million tons compared to the 8.0 million tons, implying a 31% growth as a result of export activities, which is primarily met coal. The average realization per ton for metallurgical coal, however, took a pounding as it decreased to near $128 in Q2, 2012, compared with $176 in Q2, 2011. The average per ton realization for Eastern steam coal also declined during the quarter. The demand for Eastern steam has declined lately and could substantially impact its revenues as it contributes a major portion to the sales, which stood at nearly 47% in the first half of 2012.
Margins may improve, but fall in realization could take a bite
The company reduced its selling, general and administrative expense to $210 million – $225 million besides also reducing overhead expenses. It has also pared back production of its lower quality metallurgical coals that earn lower revenues. Overall, this may push its margins up, but we also need to keep an eye on its reduced realization, which could partially or entirely write-off any gain in margins going forward.
Thermal coal consumption is expected to decline in 2012 by nearly 120 million tons compared with last year. Domestic coal prices have gone lower than the cost of operations in many regions, which led Alpha to stall production in several mines. However, the domestic coal market could improve if the natural gas price rises to a level that could cause utility companies to switch back to coal-fired generation.
Coal pricing in Asia is not healthy either. Import activities in Asia slowed down on a decline in Chinese demand. Moreover, Australian export volumes revived compared to last year, leading to increased supply. European steel production is down approximately 4% compared to 2011. Alpha reported that it is contracting with European companies at a discount compared to Asia. This could bring down its realization even further. Nevertheless, Alpha could take advantage of the improving Asian demand for metallurgical coal with its 30 million tons of export terminal capacity.
We do expect that as natural gas prices eventually rise (which we believe they will) that demand in the domestic coal markets will pick up, albeit modestly, which accounts for our still bullish longer-term forecasts. In the interim, the company is likely to concentrate on met coal export supply to stay afloat.Notes:
- Alpha Natural Resources Announces Results for Second Quarter 2012, Press Release, August 8, 2012 [↩]