Coal mining is a labor intensive endeavor with high fixed costs. That makes the weak pricing environment particularly challenging. However, as large coal companies cut their costs to adjust they are setting up for a speedy bottom-line rebound when coal prices start to move higher.
The exception that proves the rule
There is no easy way to get coal out of the ground. It requires owning or leasing land, buying expensive machinery, and hiring experienced employees. While there are some areas of give and take, there aren't many ways to skimp on owning coal land to mine and buying trucks that are the size of small buildings.
For example, Cloud Peak (NYSE:CLD) recently discussed buying secondhand equipment as a way of being "frugal" when money has to be spent. Interestingly, despite these efforts, the company's costs actually went up year over year in the second quarter. The average cost per ton was $10.81 in the second quarter versus $10.09 a year ago.
That's clearly going the wrong direction especially since the company's sales price per ton fell to $13.05 from $13.11. That's a drop of less than half a percent, so it's pretty small. However with costs going up 7%, the end result was an earnings drop of over 85%. The company still made $0.08 a share in the quarter, which is impressive given the headwinds, but the results show just how important cost is in a coal company's profit equation.
To be fair, the increase in Cloud Peak's costs was the result of scheduled maintenance that halted operations at some mines. Essentially, it had to maintain and invest in all of its mines even though they weren't all producing coal to sell. Costs in the second half should show notable improvement, which should improve the earnings picture. However, with lower coal prices, don't expect a return to 2012 profitability levels.
Cut, cut, cut
Cloud Peak isn't alone in trying to keep costs low. For example, Arch Coal (NASDAQOTH:ACIIQ) took its cost per ton down 17% year over year in the second quarter. That's a big help to the bottom line in a weak price environment. However, just being diligent on spending isn't the only way the company is saving money.
For example, Arch is divesting non-core assets like Canyon Fuel Company, which it sold for over $400 million, so it can focus on the "most value-enhancing parts of [its] business." In other words, it's selling less profitable mines. And the effort brings in cash that can be used to bolster the balance sheet in a difficult market.
More with less
Then there's BHP Billiton (NYSE:BHP); it has refocused around cost saving and efficiency improvements across its entire portfolio, which includes coal, iron ore, copper, and oil, among others. Within the coal division, management points out that moving coal "is a substantial proportion of the Group's cost base." So the "25% improvement in truck utilization" at one of its mines is a big deal.
If that type of saving can be pushed through not only to its other coal mines but also to its iron ore and copper mines, the company will notably improve its cost structure. Unfortunately, the only business that isn't in the doldrums right now is oil drilling. So efficiency improvements like this aren't going to help right away.
Not the only ones
This trio doesn't have a lock on cost containment efforts. For example, James River Coal was able to reduce costs per ton from around $77 in last year's second quarter to $66 this year. That's a nearly 15% drop. And Walter Energy (NASDAQOTH:WLTGQ) was able to reduce costs by more than 20% in its core metallurgical coal business.
When supply and demand rebalance
The cost cutting efforts across all of these companies are a vital part of the rebalancing that is taking place between supply and demand in the coal industry. When coal prices were high, companies paid less attention to mining costs and brought on mines that were only profitable if prices stayed high. Now, with prices low, miners are getting leaner. That said, because of the nature of coal mining, that higher cost production is only just starting to go away.
So prices aren't likely to rebound in the near term, leaving cost cutting as the mantra of the day. However, when prices do pick up, companies that are struggling to turn a profit today, like James River, Arch, and Walter, will see a swift boost from their efforts to trim expenses by 15% to 20%. Companies that are still doing "OK," meanwhile, will also see a boost, including Cloud Peak and BHP, strengthening their already solid business fundamentals.
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.