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

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  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 >>

You May Also Like

Trading Center