It's been a pretty miserable summer for coal companies, as low natural gas prices and sluggish steel production have eviscerated prices for both thermal and metallurgical coal. As a debt-heavy company with major exposure to the very much out-of-favor Appalachia region, Alpha Natural Resources (NYSE:ANR) has seen its stock take an absolute pounding. Although valuation suggests extreme pessimism, investors cannot afford not to consider the risk that conditions could get even worse.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Second Quarter Results - Lousy, As Expected
If there's a bright side to Alpha's second quarter earnings, it's that the Street has gotten so down on coal names that almost anything would be a relief. Revenue did rise 11% from last year, in large part due to the Massey deal, while falling 5% sequentially. The company saw a 5% sequential drop in overall tons sold, with Powder River coal shipments down 14%, Appalachian coal down about 4% and met coal up 14%. Realized pricing actually ticked up slightly, but due to a mix shift; Appalachian coal pricing was down about 4% and met coal pricing dropped another 12%. Unfortunately, it's not getting any cheaper to mine coal. Consequently, per-ton margin fell 57% from last year and 14% from the first quarter, while adjusted EBITDA fell 50%.

SEE: A Clear Look At EBITDA

Little Relief in Sight; The Cavalry Has All Switched to Gas
It's tough to see how conditions are going to turn around quickly for Alpha. Factoring in the cost of energy sources, transportation, pollution remediation and so on, the price parity for Northern and Central Appalachian coal with natural gas is around $4.00 - $5.00/MMbtu. With current Henry Hub natural gas at less than $3.00/MMBtu, that's a big problem. It is true that utilities are using more coal to cope with summer demand, but the basic pricing structure is just not encouraging for thermal coal. Clearly, this is bad news for other App operators like Arch Coal (NYSE:ACI) as well.

It's not much better in met coal. Met coal prices have dropped about 35% to 45% year on year (depending on the quality of the coal), and that's terrible news for Alpha, CONSOL (NYSE:CNX), Patriot Coal and Walter (NYSE:WLT), as well as Arch. With steel companies like ArcelorMittal (NYSE:MT) seeing little production growth and the Indian and Chinese steel sectors in distress as well, it's hard to see how prices will recover soon - to that end, Alpha talked about signing up 2.4 million tons of 2012 met coal at a price of $105 per ton.

SEE: A Primer On Coal

What makes this situation arguably even worse is the debt that Alpha took on to do the Massey deal. Alpha Natural is now a debt-heavy operator in a region with high operating costs and growing pressure from government regulatory bodies. Not only does Alpha arguably need met coal prices sustainably above $225 to $250 per ton to make the Massey deal look worthwhile, but Peabody's (NYSE:BTU) extensive Australian operators are better placed to exploit future Chinese and Indian demand growth.

The Bottom Line
In its favor, Alpha Natural has very high quality mines and coal reserves - some of its thermal coal is actually good enough to use as low-grade met coal. Assuming that the government is focused on driving Appalachian coal mining to extinction, these reserves have real value. What's more, while Alpha has a lot of debt, none of it comes due before 2015 and that should give the company more room to breathe than Patriot Coal enjoyed.

SEE: Natural Resource Investing

On the flip side, utilities are likely to continue basing their future plans around natural gas and not coal. What's more, while automated mining equipment could help Appalachian operators, companies like Komatsu (OTC:KMTUY) aren't going to be ready with this gear for many years. In the meantime, coal prices can get even worse. Taking an average of sell-side analysts' 2013 EBITDA estimate and applying a 6.5 times multiple suggests that these shares are worth almost $18. Using the lowest estimate I could find (about $675 million), the fair value drops to about $9 but still meaningfully higher than today's price. I do think we're close to a point of maximum pessimism for coal, but nobody should buy these shares thinking that a recovery is a sure thing.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Economics

    Will Silver Recover in 2016? (SLV, GLD, JJC)

    The end of the silver downtrend is likely to coincide with similar recoveries in gold, iron and copper.
  7. Stock Analysis

    The Top 5 Silver Penny Stocks for 2016 (LODE,AG)

    Learn about five of the top silver penny stocks and why investors may want to consider adding them to their investment portfolios in 2016.
  8. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  9. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  10. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center