Arch Coal’s (NYSE: ACI) third quarter performance reflected improvement over the second quarter due to cost control efforts and modestly better domestic thermal markets driven by hot summer weather and higher competing fuel prices.
Arch, one of the nation’s top coal producers, on Oct. 26 reported net income of $46m, or $0.22 per diluted share, for the third quarter of 2012 compared with net income of $9m, or $0.04 per diluted share, for the third quarter of 2011.
Arch had reported a massive net loss of $436m in the second quarter of 2012 as it wrote down operations that weren’t doing well in the depressed market environment. In the second quarter of 2012, Arch recorded mine closure and asset impairment costs of $526m, reflecting the idling of five operations in Appalachia. In addition, Arch recorded an impairment charge of $116m to reduce the company’s goodwill balance due to weak coal market conditions and the company’s decreased equity market valuation.
Arch shipped 37.5 million tons of coal in the third quarter of 2012, a decrease of 6% when compared with the third quarter of 2011 but an increase of 19% versus the second quarter of 2012. Revenues totaled $1.1bn in the third quarter of 2012, a decline versus the prior-year quarter but an increase when compared with the second quarter of 2012. Results for the third quarter of 2012 include an $80m benefit from the reversal of a previously recorded legal contingency, or $54m when adjusted for taxes and previously accrued interest expense.
“Arch’s third quarter performance reflects improvement over the second quarter due to our cost control efforts and modestly better domestic thermal markets driven by favorable summer weather and higher competing fuel prices,” said John Eaves, Arch’s president and CEO. “During the third quarter, we saw margins in both of our western regions expand due to increased shipment levels, higher price realizations and strong cost control.”
Eaves added: “Looking ahead, we believe global coal markets are in the process of correcting – with the domestic thermal market building some momentum while metallurgical markets are bottoming out. Because we expect global coal market conditions to remain challenging in 2013, Arch is executing a strategy to successfully navigate this weak market. Our plan is focused on improving operational efficiency, optimizing our asset base and preserving liquidity so we are well positioned to capitalize as the market recovers.”
“We are prudently matching our production levels to market demand, reducing costs and lowering capital spending,” said Paul Lang, Arch’s executive vice president and COO. “We anticipate that 2013 will be a difficult year for the coal industry, but we believe our ongoing efforts will allow Arch to emerge from this cyclical downturn as an even stronger company.”
Arch idled three more mines in Q3, ships first coal from Leer
In the third quarter, Arch took steps to rationalize its higher-cost metallurgical coal supply, including idling three smaller mines in Appalachia. The operations affected were Bismarck, Carlos and Imperial, which produced a total of 1 million tons of coal in 2011.
At the same time, Arch continued to optimize its diverse, low-cost asset portfolio with the build out of the high-quality Leer (formerly called Tygart Valley) metallurgical coal mine in northern West Virginia. Leer’s development is on track, with the continuous miner equipment and preparation plant now in operation. On Oct. 23, Leer shipped its first train, with customers in Europe as the coal’s final destination. Arch currently expects the longwall at Leer to start up in the third quarter of 2013, which will hugely jump the mine’s production.
Arch also continued to demonstrate strong cost control at its operations during the third quarter, driven by ongoing efforts to improve operational efficiencies across all regions, as well as increased shipment levels in the Powder River Basin and in the Western Bituminous Region. As a result, the company said it has further reduced its full year 2012 cash cost guidance range in each of its key operating regions.
Arch continues to evaluate current market conditions when assessing its future capital expenditure plans. The company expects capital spending of about $350m for 2013, below its estimated 2012 capital spending range of $410m to $430m.
“During the third quarter, we increased our cash position by more than $135 million and ended the quarter with no borrowings under our revolver,” said John Drexler, Arch’s senior vice president and CFO. “We are free cash flow positive year-to-date in 2012, and expect to end the year with roughly $600 million of cash and available funds on hand. We remain committed to preserving and enhancing our liquidity as we position Arch to successfully navigate the current market conditions.”
“Strong cost control in the third quarter led to higher cash margins in Arch’s western operating regions,” said Eaves. “In Appalachia, the effect of lower thermal volumes drove third quarter cash costs higher versus the second quarter. In addition, we shipped 2.1 million tons of metallurgical coal from Appalachia in the third quarter – 11 percent more than in the second quarter – and we expect to ship 7.5 million tons of coal into metallurgical markets during 2012.”
Arch sold 37.5 million tons of coal in the third quarter, against 39.9 million tons of coal in the third quarter of 2011 and 31.5 million tons in the second quarter of this year.
Third quarter 2012 consolidated per-ton operating margin expanded 11% versus the second quarter. Sales volumes increased 19% in the third quarter versus the prior-quarter period, driven by increased shipments in the company’s western operating regions. Consolidated sales price per ton declined 10% over the same time period, reflecting a larger percentage of Powder River Basin tons in Arch’s overall volume mix as well as lower volumes shipped from Appalachia. Compared with the second quarter, consolidated cash cost per ton declined 10% in the third quarter, driven by strong operating performances in the company’s western regions and a larger percentage of lower-cost tons in the company’s overall volume mix.
PRB coal sales jump sharply in Q2 compared to Q2
Third quarter sales by region break down as:
- The company sold 27.7 million tons of PRB coal (from the Black Thunder and Coal Creek mines in Wyoming) in the third quarter, against 21.8 million tons in the second quarter and 28.8 million tons in the third quarter of 2011. In the PRB, third quarter 2012 operating margin per ton increased 36% versus the second quarter, due to higher average realized prices and lower costs per ton. Sales volumes increased 27% in the third quarter versus the prior-quarter period as shipments rose on improving trends in domestic thermal markets.
- In Appalachia, the company sold 4.7 million tons in the third quarter, against 5.2 million tons in the second quarter and 6.3 million tons in the third quarter of last year. In Appalachia, Arch recorded an operating margin of $1.43 per ton in the third quarter of 2012 versus $3.60 per ton in the second quarter. Sales volumes declined 10% in the third quarter compared with the second quarter, as lower thermal sales offset higher met coal shipments. Average sales price per ton declined over the same time period, driven by lower prices on met shipments.
- In the Western Bituminous region (mainly longwall mines in Utah and Colorado), Arch sold 4.6 million tons in the third quarter, against 4 million tons in the second quarter and 4.2 million tons in the year-ago quarter. Third quarter 2012 operating margin per ton expanded 71% when compared with the second quarter. Shipments rose in the third quarter versus the prior-quarter period despite the planned longwall move at Skyline in Utah, as mine inventory across the region was reduced due to improving domestic demand. Average sales price increased $2.15 per ton over the same time period, benefitting from a favorable mix of customer shipments. Looking ahead, the longwall at Skyline is expected to restart at the end of October.
Arch said it believes several factors will help rebalance global coal market fundamentals and set the stage for the next rebound:
- Prompt month natural gas prices have risen nearly 25% since the end of August and the forward curve is above $4/mmBtu, making western coals a competitively priced fuel for power generation.
- While U.S. coal demand for power generation is set to decline by more than 100 million tons in 2012 due to one of the mildest winters on record and decade-low gas prices, Arch believes coal consumption will grow again in 2013.Coal demand could regain ground lost to competing fuels, including natural gas and hydroelectric power, and should increase on more normal winter temperatures.
- Coal stockpiles at U.S. power generators have declined from the record levels set in May 2012, and internal estimates suggest customer stockpiles could dip below 180 million tons at year’s end. Over the course of 2013, Arch expects further liquidation of coal inventories at domestic power generators.
- U.S. coal exports are projected to reach a record 125 million tons in 2012 even with anticipated slowing in the fourth quarter. This record level would represent a more than doubling of coal exports since 2007. During the next five years, Arch expects U.S. exports to grow meaningfully as domestic port capacity is expanded, new power plants are built around the world and growing global infrastructure needs bolster steel and met coal demand.
- Despite strong hydroelectric generation year-to-date and recent reductions in steel production in China, that country is on pace to import between 220 million and 225 million tonnes of coal in 2012. In addition, India’s recent blackouts may spur reform in the power and coal sectors, and encourage incremental infrastructure investment and coal imports over time. Longer term, roughly 85% of the world’s 7 billion people will live in emerging economies – with 1.3 billion estimated to move into the middle class by 2020. This will drive demand for resources, like coal, over the next decade.
- Met coal markets are weak currently, as global steel demand has been temporarily constrained by the economic recession in Europe and slower-than-expected growth in China. But, announced infrastructure spending in China and Brazil and stimulus spending in developed economies – along with global production curtailments and delayed mining capital investments – should tighten met coal markets in the future.
Arch still sees export market as long-term driver of coal demand
“While our third quarter results benefitted from the modest improvement in domestic thermal demand, the uncertainty in global and domestic economies could affect coal markets in 2013,” said Eaves. “Longer term, we remain encouraged by the opportunities in seaborne coal markets and our forecast of 2 billion tonnes of seaborne coal demand by 2020 has not changed.”
In 2012, Arch’s expected sales volume is 129 million to 135 million tons for thermal coal and 7.5 million tons of met coal.
“On the marketing front, we continue to manage our exposure by layering in sales as appropriate while maintaining leverage to capture potential upside,” said Eaves. “We are also working with some metallurgical and thermal customers to shift previously committed tons into 2013, and are selectively placing small tonnage into the export market for the fourth quarter.”
“Looking ahead, we will prudently manage our capital, control our costs and preserve our liquidity under current market conditions,” added Eaves. “We will also retain the flexibility to respond to improving coal market fundamentals, which we believe will occur over the course of 2013 and 2014. As market conditions improve, Arch will leverage its superior low-cost asset base to create substantial value for shareholders.”