Regulatory Headwinds Could Weigh on Massey’s Margins
Massey Energy (NYSE:MEE) is the 4th largest coal company in the United States and the largest in Central Appalachia based on produced coal revenue. Massey competes with companies like Peabody Energy (NYSE:BTU), Arch Coal (NYSE:ACI) and CONSOL (NYSE:CNX) Energy. Earlier this year, Alpha Natural Resources announced that it had struck an agreement with Massey for a $7.1 billion takeover.
We estimate that the produced coal division constitutes around 84% of our $55.08 price estimate for Massey’s stock, which is around 15% below the current market price.
Recently, a federal court for obstruction of justice indicted Massey Energy’s security chief at the Upper Big Branch mine. This is the mine where the explosion occurred last year. The security chief has been accused of destroying thousands of pages of documents that could have aided the F.B.I. and Mine Safety and Health Administration (MSHA) officials conducting a criminal investigation of the explosion. [1]
The increased scrutiny from this charge could increased the costs of regulatory compliance in the future. Massey has been using public forums to express its differences with the MSHA, its chief regulator. If MSHA believes it necessary, it can delay coal production as it did with the delay of the Longwall startup at Massey’s Revolution mine because of disagreements on a new ventilation plan for the mine. Having a fragile relationship with the MSHA can lead to increased costs because of increased MSHA inspections and delays which will could slow down production.
The company’s fourth quarter results were impacted due to reduced production and increased costs resulting from tougher mine safety standards. Its gross margins fell from 33.6% to 20.1%, with average cash cost per ton increasing by 26%. [2]
The produced coal EBITDA margin increased from around 13% in 2006 to just over 22% in 2008, as increasing global demand for coal resulted in higher profit margins for coal producers like Massey. However, in 2009 as a result of the global economic downturn demand for coal fell to resulting in EBITDA margins of around 16%. With the economic environment improving slightly in 2010, its EBITDA margin also improved, and we expect the produced coal EBITDA margin to increase to around 18% by the end of the Trefis forecast period.
However, if Massey doesn’t improve its relationship with regulatory bodies, there may be a downside to our forecast. If the EBITDA margin falls to 15% by the end of our forecast period, it would have a negative impact of around 10% on our price estimate for Massey’s stock.
See our full estimates for Massey.
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