Lurking underneath all of those adjusted earnings and EBITDA from continued operations that coal companies have posted these past couple quarters are zombie mines. These undead operations are good at one thing and one thing only: taking away the lifeblood of coal companies. For Peabody Energy (NYSE:BTU), Arch Coal (NASDAQOTH:ACIIQ), ans Alpha Natural Resources (NASDAQOTH:ANRZQ), these idled mines determine whether each company makes a profit or posts hefty earnings losses. Let's take a look at how the mass of earnings-eating mines affected coal companies, and how long we can expect this to continue.
There are two critical phrases that coal companies have used over the past couple quarters in their earnings releases: "adjusted earnings" and "from continuing operations." By using these key terms, coal companies have been able to make statements like these in their earnings releases:
- Peabody Energy: Diluted earnings per share from continuing operations totals $0.06, with adjusted diluted earnings per share of $0.05.
- Arch Coal: Third quarter 2013 adjusted net loss was $1.8 million, or $0.01 per diluted share.
- Alpha Natural Resources: Third quarter 2013 adjusted net loss was $134 million, or $0.61 per diluted share.
This past year has been extremely difficult, even for some of the better-performing companies in the space. So when a company like Peabody posts even the most incremental gain on its operations, it seems like a victory in and of itself. The problem is, though, that those phrases -- "adjusted" and "continuing operations" -- don't tell the whole story; there are lots of discontinued operations, including idled mines and equipment. This table shows how much these discontinued operations affected earnings for five of the largest coal companies over the past quarter.
|Company||Adjusted Net Earnings (millions)||Net Income (GAAP accoutning standards, millions)||Cost of zombie operations (millions)|
|Alpha Natural Resources||($134.4)||($458.2)||$255.1|
|Cloud Peak Energy (NYSE:CLD)||$18||$20.8||$0|
|Alliance Natural Resource Partners (NASDAQ:ARLP)||$87.2||$87.2||$0|
Patient zero: Central Appalachia
Zombie movie plots all seem to follow a very similar plot line: Find the first person infected -- patient zero -- to discover a cure or find a way to wipe out all the zombies. In this case, patient zero appears to be Central Appalachian coal mines. Looking at the table above, we see that Arch and Alpha incurred much larger costs from discontinued operations than players like Peabody, Cloud Peak, or Alliance. This is not a coincidence. All three of the companies that were less afflicted this quarter have little to no exposure to Central Appalachian coal mines. One of Alliance's two Central Appalachian mines -- Pontiki -- will actually be closed this December when it has fulfilled all of its sales contracts. So it is very likely that we will see some zombie mine costs for Alliance in the first quarter of 2014.
One other thing to note that sets each of these companies apart is the total amount of mines they each operate. Cloud Peak and Alliance derive coal from three and 11 mines, respectively. By contrast, Alpha has more than 130 mines in operation. The natural conclusion is that having lots of mines enables a company to spread pain around; for coal companies, however, that isn't necessarily the case. The fixed costs of mines are pretty high in comparison to variable costs, so lots of mines running at lower capacity strain earnings more than the fixed costs at a select few mines. Combine these two elements and it's pretty easy to see why each company is infected with zombie mines.
So how much longer can we expect companies to make big payments on discontinued operations? According to Arch Coal CEO John Eaves, there is still about 15-20 million tons of oversupply in the global market. Not much, but enough to prevent lots of U.S. mines from ramping up production considering the big uptick in Australian coal production. At the same time, though, Eaves estimates that the production mix of coal will continue to favor both Illinois Basin and Powder River Basin coal at the expense of Central Appalachian coal for the next couple years. He estimates that thermal coal from Central Appalachia will be as low as 18 million tons by 2015. So it's very likely that Central Appalachian coal companies will continue to shutter mines over the next few years.
What a Fool believes
Idle mines and oversupply are just two of the many problems plaguing coal today. Some companies have been looking at other potential sources of revenue to break out of the slump in coal. It is likely that these companies will continue to highlight their adjusted and continuing operations numbers for a while, as net income numbers will probably continue to look weak.