It is difficult to report profits if you are a coal company nowadays. Arch Coal (NYSE: ACI) is no exception, and the company's recent fourth-quarter report showed an eighth consecutive quarterly loss. Unfortunately for Arch Coal, this trend is going to continue.
Thermal coal yet to recover
Last year, both thermal coal prices and met coal prices were under significant pressure. In its fourth-quarter earnings release, Arch Coal stated that it believed that thermal coal markets were gaining momentum. Severe weather and elevated natural gas prices surely contributed to these developments.
Arch Coal's internal estimates showed that coal consumption for power generation rose by more than 35 million tons in 2013. This could be a healthy sign but it has yet to translate into a meaningful increase in prices.
I think that thermal-coal-heavy names like Arch Coal and Peabody Energy (BTU) could not count on major improvements on the price front in 2014. In contrast with Arch Coal, Peabody managed to stay profitable in the last three quarters. Despite this fact, the company remains vulnerable to any downside in prices.
Met coal prices will remain depressed
The situation with met coal remains dire. The share price dynamics of met-coal-heavy Walter Energy (WLTGQ) and Alpha Natural Resources (NYSE: ANR), which are down 35% and 25% respectively, reflects that fact.
Arch Coal booked 3.5 million of its 2014 met coal production at $85 per ton, down from $90 in 2014. While coal companies in their reports state that these low prices are unsustainable in the long term, the downside trend does not change. Arch Coal states that it has a long-term strategy of becoming a larger player in the met coal, but in the current environment this statement looks dubious.
Met coal price data from Arch Coal brings no relief for shareholders of Alpha Natural and Walter Energy before their quarterly reports which are due on February 12 and February 20 respectively. Met coal market remains oversupplied, with most of the excess supply coming from Australia.
In fact, BHP Billiton (BHP 0.65%) will produce an additional 5.5 million tons of met coal annually from its Caval Ridge mine in Australia, which is expected to deliver first production this year. BHP has already increased its met coal production by 13% consecutively in the fourth quarter. What's more, continuing weakness in the Australian dollar encourages met coal production growth in the country.
Cost cutting has its limits
Arch Coal's 2014 capital expenditures will be less than $200 million, down from $297 million in 2013. It is unlikely that the company will be able to spend less than that going forward. In addition, there are significant expenditures which could not be cut. I'm talking about interest expense, which is projected to be between $385 million and $395 million in 2014.
Arch Coal anticipates that costs at its Powder River Basin operations will be slightly higher than previous year's levels, while it expects lower costs in its Appalachian operations. I think that one can safely assume that Arch Coal's costs have more or less found their floor.
The facts presented in this article could have been bearish for Arch Coal if we didn't take into account the company's share price. The stock has suffered a lot in the recent years and already reflects the headwinds that Arch Coal has to deal with. Importantly, the company managed to refinance a part of its debt in December. As a result, it has no major debt repayments before 2018, which gives Arch Coal a room for maneuver. And this is just what it needs now, as coal prices are likely to recover in the long term.