More Profit Warnings From Big Coal

Arch Coal just warned that third-quarter sales volumes will be softer than expected; such warnings are starting to look like a common theme -- but one that could make 2014 look relatively good.

Jan 24, 2014 at 2:29PM

Arch Coal (NYSE:ACI) just joined Peabody Energy (NYSE:BTU) in forewarning investors of weak fourth-quarter results. Most miners will see a similar trend even if they don't pre-announce. However, as an investor, now isn't the time to get caught up in what has happened but to discern what may happen in 2014.

Volume shortfalls
Arch Coal mines thermal coal in the Powder River Basin (PRB) and metallurgical coal. The company just warned that its thermal shipments fell by a massive 15% sequentially in the fourth quarter, largely because of weather-related disruptions. That's going to make margins weak and leave the top and bottom lines softer than they otherwise would have been.

That said, Arch isn't the only one to warn about a weak fourth quarter. For example, industry heavyweight Peabody Energy issued a similar warning. Peabody's big problems were a now resolved labor strike, delays in getting a new mine up and running, and its costly settlement related to Patriot Coal's bankruptcy. However, both miners are big in the PRB, which the Energy Information Association notes saw a 2% volume decline last year. So it isn't surprising that this pair would be reporting weak results.

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Source: EIA

But the weakness at both Arch and Peabody is setting up comparatively stronger 2014 results. For example, Peabody's issues are largely resolved and one-time in nature. And according to Arch CEO John Eaves, "Although rail disruptions affected our PRB operations in the fourth quarter, we would expect to make up a majority of those shipments during 2014." In other words, look for a boost to PRB volumes this year.

Bigger issues
Arch, however, has other issues to deal with: weak metallurgical coal markets. In its pre-announcement the company noted technical issues causing a volume shortfall on the met side of its business, but price is the real problem to monitor. Although Alpha Natural Resources (NYSE:ANR) hasn't warned about its fourth quarter, don't be surprised if met coal issues cause it to do so, too.

Both Arch and Alpha were affected by the same trends that hit Teck Resources (NYSE:TCK) in the third quarter. Don Lindsay, CEO of this diversified miner that is heavily focused on met coal, stated in the third quarter, "the current price for steel making coal remains below what we believe is required to sustain adequate production in the industry in the long term."

Despite record coal volumes, Teck's third-quarter earnings were off by nearly 40%; clearly price was a big problem. Look for the same thing to happen when the company reports fourth-quarter numbers even though the met market has firmed up a bit of late. And don't expect much positive news from Alpha or Arch on the met coal front.

And since met coal makes up about 45% of the business at Arch, Alpha, and Teck, this is really the area to monitor going forward. That said, Alpha also has notable thermal-coal operations on the East Coast, which adds additional thermal coal risks since PRB coal is better positioned pricewise.

Indeed, the EIA believes PRB coal is likely to see an uptick in demand in 2014 because of low stockpiles at utility customers. So while Peabody and Arch will benefit if the EIA's expectations come to fruition, Alpha won't see the same boost and will still have to suffer through the troubles on its met side.

Copper and zinc are the other big businesses at Teck. Zinc has been a solid performer, but copper weakness has been an offset. Unfortunately, that leaves met coal as the big determinant of results.

Low expectations
At the end of the day, investors probably aren't expecting much from coal-company results in 2013. And proving weak expectations true isn't really all that bad. But what you might want to keep in the back of your mind is that the news out of Peabody and Arch is suggesting that there could be some unexpected coal bright spots in 2014. Look for these silver linings since they could lead to price gains for the best positioned companies.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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