What's the Biggest Threat to Alpha Natural Resources Inc?

A weak outlook for met coal could mean pain ahead for Alpha Natural Resources.

Mar 11, 2014 at 10:34AM

Exposure to met coal production continues to be viewed as a disadvantage for a coal producer. Alpha Natural Resources (NYSE:ANR) is a vivid example of this: Its shares have already lost 33% since the beginning of the year, while the thermal coal-heavy Arch Coal (NYSE:ACI) trades at levels seen in early January. Alpha Natural Resources' revenue was equally split between thermal coal and met coal in 2013. As the outlook for met coal prices deteriorates further, it is likely that the company's shares may experience even more downside.

Alpha Natural Resources has problems at current market prices
The met coal that Alpha Natural Resources sells is not of the highest quality, and it is priced with a significant discount to the benchmark price. The company received $96.53 per ton of met coal in the fourth quarter of 2013, while the benchmark price remained above $140. What's more, the company's cash flows remain exposed to further downside on the met coal price front, because only 56% of Alpha Natural Resources' projected sales volume in 2014 was committed and priced at $94.66 per ton.

In comparison, Walter Energy (NASDAQOTH:WLTGQ) received $137.39 per ton of its highest quality met coal and $118.63 per ton for lower quality met coal in the fourth quarter. However, the company's indebtedness continues to weigh on its shares, and Walter Energy is down as much as 37% this year. On the bright side, Walter Energy managed to swing to a positive cash flow from operations in the fourth quarter. Unfortunately, further deterioration of the met coal price will likely push Walter Energy's operational cash flow back into the negative territory.

The situation in the thermal coal market looks better, as natural gas prices remain at higher levels than in the previous year. However, Alpha Natural Resources has already committed and priced 98% of its Powder River Basin steam coal production at $12.12 per ton and 76% of its Appalachian steam coal production at $58.88 per ton. In comparison, Arch Coal managed to commit and price its Powder River Basin production at $13.18 per ton. In the case of improved thermal coal pricing conditions, Alpha Natural Resources' benefits will be significantly limited, because the company has already signed contracts for most of its production.

Environmental agreement adds to the pressure
Alpha Natural Resources has recently announced that it entered into an agreement with the U.S. Environmental Protection Agency. Under this agreement, the company will pay $27.5 million in civil penalties. What's more, Alpha Natural Resources will dedicate $160 million of capital expenditures over the next three years to achieve water quality compliance.

Additional expenditures are not good news for the company's shareholders, as its cash flows remain pressured by weak prices. The company had $619.6 million of cash at the end of the year, so it is unlikely to experience short-term liquidity problems. Alpha Natural Resources' fourth-quarter operational cash flow was negative, and this is a worrying sign.

The company targeted $250 million-$300 million of capital spending this year. If operations do not contribute funds to the spending program, Alpha Natural Resources will be forced to seek cash elsewhere. In addition to the above-mentioned problems, the company will have to pay $240 million-$250 million of interest on its $3.4 billion debt this year.

Bottom line
Alpha Natural Resources is experiencing significant headwinds. The company produces lower quality met coal, and pricing for this type of met coal is under more pressure than the pricing for high quality met coal. Heavy debt continues to weigh on the company's performance through interest expense. All in all, Alpha Natural Resources' shares could experience more downside this year. 

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Vladimir Zernov 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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