Arch's Nemesis: Weak Coal Prices

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Arch Coal (NYSE: ACI) has a name any arch-capitalist should love. Whether the business itself is lovable is not as immediately obvious. Following the lead of International Coal Group (NYSE: ICO), Arch just reported somewhat lousy numbers for the second quarter, and cut its financial guidance for the full year.

Thanks to well-stocked electric utilities (the largest consumers of coal), the market for coal has been pretty weak this year. Arch's average price realizations came in lower, on both a year-over-year and sequential basis, and revenue fell 6% year over year. Higher unit costs put a squeeze on operating margins, which are at less than half their year-ago levels. Margin pressures are also likely to hang around for a while. Who invited those guys, anyway? Actually, the company did, by actively scaling back production. It's a matter of economies of scale -- smaller operating base, higher unit costs.

Arch increased its low-sulfur Powder River Basin coal sales this quarter, which is not a good thing, considering that the company's operating margin per ton in that region has collapsed from $2.80 to $1.10. This variety of coal is abundant and overproduced at present. A glance at Central Appalachian operating metrics provides a striking contrast -- margins have actually risen there.

Arch's leverage toward PRB coal spells near-term trouble, but it's also a key differentiator for the company. In contrast, Peabody Energy (NYSE: BTU) only shipped a little more than half its total coal out of the prolific PRB last year.

If pricing is so weak there, how is Arch's concentration in the region a good thing? Well, the thing about PRB coal is that it burns cleaner than bituminous coal. In the days before emissions standards, PRB coal was worthless, because of its lower energy content. Environmental regulations change the calculus significantly. As long as competing solutions like scrubbing technology remain more expensive than using low-sulfur coal, the fundamentals for PRB coal look quite strong. So, too, for Arch Coal.

Related Foolishness:

• Saluting Patriot Coal
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International Coal Group is a Hidden Gems Pay Dirt recommendation.

Fool contributor Toby Shute doesn't own shares in any company mentioned. The Motley Fool has a disclosure policy.