More Red Ink at Arch Coal and Alpha Natural Resources

Met coal will keep results at Arch Coal and Alpha Natural Resources down again this quarter, but Arch has another issue to deal with.

Jul 24, 2014 at 3:05PM

Arch Coal (NYSE:ACI) and Alpha Natural Resources (NYSE:ANR) are likely to post losses when they report second quarter earnings. However, there are some bright spots to watch and trouble spots to monitor when they do.

The big met
Metallurgical coal made up 20% of Arch Coal's top line last year. Met coal accounted for nearly half of Alpha Natural Resources' revenues in 2013. Unfortunately for this pair of coal miners, met coal, which is used in steel making, is still facing an oversupply situation right now.

That alone will be enough to keep earnings weak in the second quarter, though the impact will clearly be more pronounced at Alpha Natural Resources. But because margins in the met market have historically been wider than margins in the thermal market, Arch Coal isn't going to escape the pain just because it has less exposure. Make sure to watch for an update of the metallurgical coal market when these two miners report.

(Source: Alfred T. Palmer, via Wikimedia Commons)

The positive side of the picture
That said, you should also be looking for continued good news on the domestic thermal coal front. Natural gas prices remain in the mid $4 range. While that's still historically low, Powder River Basin (PRB) coal is price competitive with gas priced as low as $2.50, and the Illinois Basin can compete with gas priced between $3.50 and $3.75. Even Central Appalachian (CAPP) coal starts to get price competitive when gas is above $4.50.

So watch for good news on the thermal front. Alpha Natural Resources only got about 10% of its revenues from the PRB last year, and the region accounts for just 16% of its reserves. So the uplift from an improving outlook for PRB coal won't help all that much. However, the company's Eastern Thermal segment, which represented about 40% of its top line in 2013, should be closely scrutinized. Key questions to ask are how the segment is doing in the domestic market and how the export market is holding up.

Not so good, good news
For Arch Coal, where PRB coal accounted for 45% of the top line in 2013, natural gas prices at recent levels should be a huge positive. And while that's definitely true, a tough winter has left the company at the mercy of the railways on the delivery front. In the first quarter, Arch Coal CEO John Eaves had the displeasure of explaining, "we are encouraged by the strengthening dynamics in the U.S. thermal market ... [but] the impact of rail performance issues [remained a challenge]." You don't make money if your coal doesn't get delivered due to bad weather.

Don't expect too much good news with Arch Coal's rail troubles in the quarter because Kansas City Southern (NYSE:KSU) just reported earnings, and it didn't sound like things were straightened out yet. Pat Ottensmeyer, Executive Vice President of Sales and Marketing at Kansas City Southern noted, "No doubt that our utility coal business could have performed better this quarter, were it not for congestion and service problems experienced throughout the North American rail network." That said, he sounded more positive about the future.

(Source: Mark Levisay, via Wikimedia Commons)

Since Kansas City Southern is right in the thick of the train issue, these second quarter comments suggest that rail congestion will hit Arch Coal's numbers again in the second stanza. That said, listen to see if the problem is finally getting better. That could make the second half of the year particularly strong for Arch Coal as shipments pick up to make up for first half delivery delays.

Where's the light?
At the end of the day, Arch Coal and Alpha Natural Resources are still struggling to turn things around. They've done pretty much all they can on the cost side of the equation and are now at the mercy of other factors. Although this will be another tough quarter, listen closely for positives—they could be the sign that things are starting to turn for the better.

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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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