Who's Winning the Met Coal Waiting Game?

While all met coal producers are short term losers, cost-effective ones have good chances to profit in the longer term.

Jun 24, 2014 at 8:42AM

Back in 2011, met coal producers were very optimistic. Prices were rising as demand ramped up, and miners were growing their production levels. Walter Energy (NASDAQOTH:WLTGQ) and Alpha Natural Resources (NYSE:ANR) took loads of debt to finance the acquisitions of Western Coal and Massey Energy, while BHP Billiton (NYSE:BHP) approved three met coal projects.

Since then, the situation has changed dramatically. Met coal prices suffered a severe downside as new supply flooded the market while demand failed to increase to the desired level. During the downturn, producers took a wait-and-see approach and were reluctant to cut production, hoping that the pricing environment will soon change to the better. That did not happen, and the downturn has drawn a fine line between the strongest and the weakest.

Admitting mistakes
It took a long time before Walter Energy finally admitted that the cost level at its Canadian operations was unsustainable. The company has decided to idle them, but that happened just this April. This hesitation could prove costly for Walter Energy, especially as its stock has been under extreme pressure this year. The company has forced itself into a corner and has to take drastic measures to stay afloat. Walter Energy had to agree to high interest rates when refinancing a part of its existing debt while cutting its capital spending to sustaining levels. The good part of the story is that this year's actions and capital scrutiny provide the company with room for maneuver.

Alpha Natural Resources was also slow to admit the met coal world has changed. The fact that the company produces lower-quality coal than Walter Energy adds to the pressure on its bottom line, because lower-quality met coal pricing suffered most. However, Alpha Natural Resources' debt situation is easier. The company's production has basically already been sold off for this year, making the outlook for Alpha Natural Resources relatively stable.

Costs are paramount
Cost leaders like BHP Billiton and Teck Resources (NYSE:TCK) are in a better position. However, they cannot ignore lower prices. Teck Resources' first-quarter earnings fell by almost 80% compared to the first quarter of last year, and met coal was a major contributor to this decline. In its most recent earnings call, Teck Resources admitted that it had absolutely no plans to cut met coal production. Instead, the company was waiting for others to pull their production from the market.

BHP Billiton's tactics are the same. The company is committed to simplifying its portfolio, and met coal will remain one of the main pillars for BHP Billiton. It's the non-core assets whose fate is to be divested. For example, the company stated that it was reviewing options for its Nickel West business in Australia. This announcement came at a time when nickel prices were enjoying a bull market, so the company is serious about sticking to its main products while selling other businesses.

Bottom line
So what's the result of the met coal waiting game? In the short term, all met coal producers are losers as low prices eat into their profits. In the longer term, cost-effective producers like BHP Billiton and Teck Resources could enjoy a bigger market share and less competition as weaker players will be cutting production or leaving the market.

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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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