Virginia-based Alpha Natural Resources (NYSE:ANR) is one of North America’s largest coal producers. The firm mines and processes metallurgical (met) and thermal coal (also known as steam coal), and also markets coal produced by other miners. The firm had revenues of around $8.7 billion in 2011, with EBITDA margins of around 13%. The past two years have been difficult for most coal companies due to stricter environmental norms, competition from cheap natural gas and weaker global demand for met coal. Through 2012, Alpha’s stock has lost about half its value. Here we provide a brief overview of the firm, its operations and the factors driving its performance.
Overview Of Products And Operations
The firm owns around 1.5 billion tonnes of met coal reserves and around 3.2 billion tonnes of steam coal reserves. Steam coal is primarily used by utility firms and the industrial sector as a fuel in electricity generation.  This division accounted for more than 80% of the firm’s sales volumes in 2011, and contributes to around 43% of our $9.50 price estimate.
The firm produces two varieties of thermal coal classified as Powder River Basin, produced at its mines in Wyoming and Eastern steam coal and produced in the Appalachian region. PRB coal has a lower heat content and relatively low sulfur content. Prices are about one-fifth of those for Eastern steam coal.  The firm’s thermal coal is sold primarily in the North American market. However, the firm is gradually expanding exports as well. Competitors in the thermal coal space include companies like Peabody Energy (NYSE:BTU) and Consol energy (NYSE:CNX).
Met coal is primarily used to produce coke, a raw material used in steel making. Met coal is more expensive than thermal coal due to its higher energy content and lower ash content. Also, prices are currently about double than those of Eastern steam coal. Following the acquisition of Massey Energy last year, ANR became the largest met coal producer in the U.S. and the third largest producer in the world. The metallurgical coal business primarily caters to the export market (around 75% is exported). The firm has annual terminal capacity of over 25 million in the East, and the gulf coasts give it good access to markets in Europe, Asia and Latin American. India and Brazil are among the largest markets for the firm’s met coal division. Teck Resources (NYSE: TCK) and BHP (NYSE: BHP) are its rivals in the met coal space.
Factors Driving The Business
Thermal coal demand is largely driven by the weather, which impacts the demand for electricity. During peak summer and winter, electricity consumption increases due to the increase in cooling and heating requirements, thereby increasing demand for thermal coal. A portion of thermal coal demand is also cyclical, as in a stronger economy, demand from the industrial sector is likely to be higher. Demand for thermal coal also depends on the prices of other fuel sources such as natural gas and oil. Rising prices for substitutes of thermal coal (such as natural gas) have a positive impact on coal prices as well. On the other hand, the demand for met coal depends primarily on global steel production. Met coal is more or less directly tied with the health of the broader global economy given that steel production varies with infrastructure spending and the health of the automobile industry.
The firm’s business is relatively capital intensive with capex coming in at around $700 million last year. ANR’s relatively large scale gives it economies of scale when demand is strong. However, this proves to be a drawback in a downturn as fixed costs are relatively high in the business. Demand forecasting is another key challenge in the industry, given that changing production output takes time. An increase in demand will lead to a rapid decrease in coal inventories and push prices up significantly.
Lower natural gas prices and stricter environmental regulations under the Clean Air Act, are making it less attractive for electric utility firms to construct and operate coal-fired power plants in the U.S. The capital investment required to build a coal-fired plant with all the necessary emission control equipment is more than double than that of a modern natural gas power plant.  Also, given the lower fuel costs and the better environmental profile of natural gas, many utilities are opting for natural gas to replace their older coal-fired capacity. Over 9 GW of coal-fired power capacity was retired in 2012 and up to 60 GW could be retired in the near future, potentially impacting met coal demand. To temper the effects of a weak domestic market, the firm has been focusing on developing export markets for thermal coal. (See Also: ANR Has A Big Opportunity In Thermal Coal Exports)
The firm’s met coal business has been impacted by excess supply and weak global demand, which have caused prices to fall by nearly 25% over the last year. However, the markets are expected to return to equilibrium shortly, following production cutbacks from miners in the U.S. and Australia. Additionally, demand from China could rise going forward, given the country’s ambitious new infrastructure plans which could see the country spend as much as $160 billion on new roads, ports and waterways. (See Also: Alpha Natural, Coal Stocks Jump On China Infrastructure Plans)Notes: