Arch Resources: Energy Cost Trumps Climate Cost, And Arch Is A Winner (NYSE:ARCH)

Coal Mining in West Virginia

JodiJacobson/E+ via Getty Images

Has anyone ever got that sinking feeling when buying a stock? Historically the capital markets were an alternative place for enterprise to seek investment instead of going through bankers, so when you buy a stock, that’s exactly what you’re doing. Today we’re going to put morals and the climate crisis aside and focus on Arch Resources (NYSE:ARCH) who are currently experiencing a purple patch.

Arch Resources, formally known as Arch Coal, is the second largest coal miner in the USA, second to Peabody, it operates coal mines in Wyoming, Colorado, and West Virginia, and it has a market capitalisation of $2.8 billion. Before we get into the Company numbers, we’re going to look at the coal sector in general. Here at the Evidence Lab towers, we’re no strangers to the coal sector, our mining guru is a former geologist, and we have also extensively covered Glencore in these past 6 months. One of our motives for investing in Glencore was its coal portfolio, which it acquired at a cut price from BHP and is proving to be very fruitful in this period – despite investor pressure to spin off the assets. For those who are not so familiar with the black stuff, it can be characterised into two different types:

  1. Coking or metallurgical coal: which is the coal needed to make coke, a vital part of the steel making process.
  2. Thermal coal: which is used in heating especially in coal fired power plants.

Over the last decade, coal use has halved in the US thanks to the advent of cheaper alternatives such as natural gas and renewables. However, over the past 12 months, these conditions have completely changed as natural gas prices have spiked, exacerbated by the Russian invasion of Ukraine. This led to an increased demand for coal which had also seen stockpiles depleted and thus, miners have been forced to increase production.

Despite calls from the US president Joe Biden to end carbon emissions from power generation by 2035, and industry also planning to phase out coal generated power, last year was the first annual rise in coal power generation since 2014. We are seeing a similar situation in Europe: Germany, who plan to phase out coal power generation by 2030, are firing up redundant coal power stations again. Coal produces roughly twice the carbon emissions as natural gas when burnt.

What about Arch?

These conditions can be seen in Arch Resources’ financial results. For the second quarter in a row, the Group has delivered record net income. As far as volumes are concerned, thermal coal is king, with volumes of 18.2 million tons, up from 12.3 million tons in the previous year’s Q1 compared to coking coal’s 1.5 million tons. But as far as revenues are concerned, metallurgical coal is king: coal sales per ton are $255.52 compared to the $18.85 per thermal ton. But maybe the most jaw dropping metric is the growth in margins from the previous year: in Q1 2021 the cash margins per ton were $24.14 and $0.98 for coking and thermal coal respectively; in Q1 2022 they grew to $167.48 and $5.42 for coking and thermal coal respectively.

Arch Resources Q1 P&L

Arch Q1 P&L (Arch Resources)

While this period obviously won’t last, it’s interesting to see how Arch is capitalising on the good times. It announced in the first quarter that it has repaid $281.7 million of debt, restoring the balance sheet to a net debt neutral position. Also there was an interesting comment from CFO Matthew Giljum regarding the strategic plan for legacy thermal assets:

“We are capitalizing on this period of historically strong thermal coal prices by pre-funding the long-term closure obligations of our legacy Powder River Basin operations,” Giljum said. “In doing so, we are setting the stage for strong, continued cash generation from these assets even as we move forward with winding them down in a careful and responsible manner.”

Another interesting takeaway from Arch’s Q1 was the use of thermal coal for metallurgical purposes given the huge price increases.

Arch is trading in line with peers with a forward EV/EBITDA at 2.3x. As core value investors, we take comfort from the return of capital policies enacted by the Group, they are currently undergoing a share buyback program and are currently returning very high variable dividends to investors with the latest having a fixed component of $0.25 per share and a variable of $7.86 per share. We swallow our environmentalist pride and rate the stock with a buy, leaving our readers with the question, is it our responsibility as investors to invest in the change we want to see in the world?

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