The coal industry has seen a minor revival in the past two years as global supply of most energy commodities has shrunk. The price of thermal coal has risen to more than $400 a ton, from around $50 a ton two years ago from. There was a large initial rally in coal last year as shortages of crude oil and natural gas began to worsen. However, global coal demand has increased much more in 2022, as Europe’s dependency on Russian natural gas is tested. For now, this generally hated energy source is Europe’s best hope for keeping the lights on. In the coming monthsprobably creating a world’s greatest shortage of coal.
Coal inventories in the United States have increased dramatically over the past two years. Prior to 2020, many coal companies were on the verge of bankruptcy and struggling with chronically negative profit margins. At the time, it looked like there was good reason to believe the coal depression was ending as valuations hit rock bottom levels, and it looked like the US shale boom was nearing its end. end. I covered this opportunity in late 2019 in “Contura Energy: The Company To Buy If Coal Prices Have Bottomed”. Since then, Contura has grown over 1,400% and rebranded itself as Alpha Metallurgical Resources (New York Stock Exchange: AMR), signifying its switch to metallurgical coal. See below:
Since 2019, Alpha Met. went from the brink of bankruptcy to a major player in the metallurgical coal market. Despite its 14X gain, the stock’s valuation remains low, with a forward P/E of only 1.2X. That said, its outlook has weakened in recent months due to the slowing global economy, leading to a dramatic drop in demand for metallurgical coal. Metallurgical coal is used for steelmaking and steel is very cyclical. While thermal coal prices remain near historic highs, international coking (metallurgical) coal prices have fallen recently, although they are still two to three times above normal levels.
Metallurgical coal demand will fall with steel
China uses about half of the world’s steel, but has apparently completed its industrial transition, meaning its long-term steel demand may have peaked. As recently detailed in “US Steel: Negative Earnings Likely, But Undervalued In The Long Run,” the continued decline of China’s construction industry could lead to a long-term and potentially permanent decline in Chinese demand for steel. Of course, many countries around the world have yet to experience industrialization, but for now, global skyscraper construction has probably peaked. That said, India remains a vital area of industrial growth and India is one of the biggest exporters of Alpha Met.
Additionally, the US manufacturing economy is slowing at a rapid pace. Historically, there has been a strong correlation between the US ISM manufacturing PMI (a leading indicator of GDP growth) and US steel production. The manufacturing PMI has been in steep decline since 2021 and could soon reach a contraction zone (below 50), indicating a sharp decline in steel production. See below:
We will likely see significant and sustained declines in demand for metallurgical coal in the future. Thermal coal remains strong, but unfortunately Alpha Met. shifted its production from mainly thermal coal to almost entirely metallurgical coal. The company is now the largest domestic producer and exporter of metallurgical coal, but that may mean it has too much exposure to a cyclical asset as construction demand wanes. Most likely, this will lead to a sharp drop in AMR profits; however, its low valuation may now explain this change.
Earnings outlook for Alpha Metallurgical
According to the company’s latest investor presentation, last quarter the company sold coal for around $189/tonne and exports at $297/tonne at an average global price of $243/tonne. Comparatively, it produces coal at around $107/ton, giving it a solid profit of over $100 per ton sold. Prices for U.S. “High Vol B” metallurgical coal ranged from $300 to $500 last quarter, but have since fallen to $285 today. Alpha Met’s selling prices appear to be lower than the “High Vol B” index, so we can only estimate with a high margin of error. That said, the roughly 30% drop in metallurgical coal prices suggests an almost 50% decline in Alpha Met’s profit per tonne from around $136/tonne ($243-$107) to $70. /ton (0.7 X $243 – $107). Again, there is uncertainty in this estimate, but overall it looks like lower coking coal prices are expected to lower AMR’s third-quarter earnings by 40-50% from the first-quarter level. .
The company generated EPS of $20 last quarter and cash flow per share of $17.2. These numbers were well above normal levels, in line with the 2020 coking coal price hike earlier this year. See below:
Given my expected margin reduction, it looks like Alpha Met’s Q2/Q3 EPS is more likely to be around $8-$12. Analysts currently expect the company’s earnings to decline, but not as large as seems likely given the drop in metallurgical coal prices.
Assuming prices remain constant, I expect the company to deliver EPS of $36-$48 over the next year. Although not as strong as the current forward estimate of $99, this still gives AMR a very low forward “P/E” of 2.5X – 3.4X. Even though its earnings have fallen 75% from first quarter levels, it would appear that its valuation is low, especially in light of its strong reserves and the quality of its balance sheet which has improved considerably. See below:
The company took advantage of its strong earnings season to reduce debt and improve working capital. Last month, the company prepaid $99 million on its term loan, eliminating the remaining balance of its term loan. The company has also authorized a $600 million share buyback program, giving it a return on capital of around 26% at current market capitalization – although I expect that figure to decline with its profits.
Overall, my view on Alpha Metallurgical is similar to my view on US Steel. The company’s valuation is extremely low, although we are counting on a potential large drop in earnings. The coal and steel metallurgical industries are likely heading for another tough time. However, as with US Steel, Alpha Met. has a recent history of emerging from tough times learning and more efficiently, improving its long-term competitive advantage. For long-term investors, that makes Alpha Met. a decent game, especially considering the demand for metallurgical coal will still exist (as long as steel is used) even if the thermal coal is eventually removed. Investors shouldn’t expect its bumper first-quarter earnings to persist, but I don’t think the stock is overvalued, even with a potential 50-75% drop in long-term earnings.
However, AMR may be best avoided for risk-averse investors looking to avoid potentially large short-term declines. I think the consensus analyst’s EPS outlook for the AMR looks a little high given the accelerating economic transition, which gives the stock a high risk of earnings revisions. Trying to catch “falling knives” is risky and, given the surge in prices, I can imagine that many AMR owners are looking to take profits. Of course, AMR also has a higher short interest of 8.7%, and more short sellers can turn to the company. As such, I’m officially neutral on the stock as it appears to present a decent risk of continuing to decline despite its low valuation.