Our Take On ANR’s Metallurgical Coal Business

by Trefis Team
Alpha Natural Resources
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Alpha Natural Resources (NYSE: ANR), one of America’s largest coal producers, is facing difficult times as the broader coal industry reels from weaker prices, stricter environmental norms and competition from cheap natural gas in the United States. The stock has lost more than half its value over the past year. And in order to get back on track, the firm has taken a three-pronged strategy focusing on higher grade thermal coals, tapping into the international thermal coal market and strengthening its metallurgical (met) coal business.

In this article, we focus on the met coal division, since it is already well established globally, and accounts for more than 40% of the firms annual revenues. Here we explore some of the benefits as well as opportunities and challenges the business faces.

Where Does The Firm’s Met Coal Division Stand?

Metallurgical (met) coal is used in the steel industry to produce coke, a reducing agent used to convert iron ore into steel. Met coal has a higher energy content and lower ash and sulfur content compared to thermal coal.  ANR is the largest met coal producer in the U.S. and the third largest producer in the world. The met coal business accounts for 40% of ANR’s Trefis price.

Met coal prices are at least double than that of thermal coal.  However, the market has suffered this year due to excess supply and weaker demand from Europe and China, which has caused prices to decline by nearly 25% since last year. Supply rationalization seems imminent as producers in the U.S. and Australia have curtailed their production by up to 30 million tons. Also the prevalent market prices are estimated to be below the production costs of nearly a third of the global met coal producers, which would make the prices unsustainable.

Why Is It Attractive?

Geographically Diversified: Unlike the thermal coal business which relies on the U.S. market (only about 7% is exported) met coal is primarily geared towards exports (about 75% is exported), allowing the firm to diversify a large portion of its revenue stream.  ((ANR Investor Presentation)) A significant part of exports are made to Italy, India, Turkey, Ukraine and Brazil.

Asset Base and Production: The firms met coal reserves account for almost a third of its total reserves at around 1.5 billion tons, however met coal production accounts for less than 20% of overall shipments (less than 20 million tons last year). This could give the firm considerable scope to scale up met coal production when required.

Strong Terminal Capacity: ANR has significant capacity in the East coast, primarily in Virginia and Maryland as well as the Gulf Coast, giving the firm good access to the European, Asian, Latin American and African markets. The firm’s total port capacity presently stands at around 25 to 30 million tons annually, allowing room for the firm to ramp up exports. The firm also owns a 41% stake in Dominion Terminal Associates in Virginia.

Emerging Markets Demand: Most of the growth in steel production is expected to come from emerging markets. Steel use in developing countries has grown by nearly 44% over the last 5 years, while it has declined by nearly 15% in developed nations. [1] India was the firm’s largest export market last year accounting for nearly 15% of total export revenues last year. Previously, Brazil was the firm’s largest export market.

Ability to Substitute Thermal Coal: A large portion of these met coal reserves have the characteristics that can allow them to be marketed as high grade thermal coal. This will allow the firm some flexibility to take advantage if thermal coal price rises in the future.

What Are The Risks It Faces?

Cyclical Demand: Met coal demand is tied to the business cycle due to its dependence on the steel industry. Steel production typically falls during recessions as demand from the automobile and infrastructure sectors declines, this in turn impacts the demand for met coal which is used in steel production.

Currency And Emerging Market Risks:  Emerging markets such as India have encountered inflationary pressures that have led governments to tighten liquidity in the system, which has in turn impacted spending on infrastructure, and consequently the demand for met coal. Being export oriented, the met coal business is also vulnerable to strengthening of the U.S. dollar. The U.S. dollar has been gaining against currencies like the Indian rupee and Brazilian real. This could impact ANR’s sales in these markets as its produce would be more expensive. It could also bring about price competition among U.S. manufacturers competing for business in these countries.

Quality of Output: While the firm produces higher quality met coal than what is available in China and emerging markets, it still trails some manufacturers such as Teck Resources (NYSE: TCK) and BHP (NYSE: BHP), which are well positioned in the premium hard coking coal market. ANR’s variety is largely composed of “hi-volatility B” coal which is more volatile than premium hard coking coal.  ((All Coking Coals Are Equal, But Some Are More Equal Than Others, Seeking Alpha)) Premium coals produce a higher quantity of coke.

We have a price estimate of 9.53 for ANR, which is in line with the current market price.

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