Divestor

For historical context, read my December 2019 post on Arch Coal where I give a primer on coal mining and discuss Arch Coal.

This is a short briefing update on the renamed company, Arch Resources (NYSE: ARCH).

My timing from the December 2019 post was a bit botched up – indeed, at one point I exited the entire position (during the Covid crisis) but later took a very healthy position at lower prices than they are trading at today. It is a large but not gigantic position currently. I am expecting it to get larger by virtue of appreciation.

Between then and now, other than Covid-19, the other major setback they hit was the regulatory blocking of the merging of their Powder River Basin thermal coal operation with Peabody Energy. This probably cost the company tens of millions of dollars a year in synergies.

It also turned out that they engaged in poor capital allocation. They bought back way too many shares in the 2017/2018 coal boom and were forced to tuck their tails behind their backs when doing some subsequent debt and convertible debt financings to fund the $390 million Leer South Project, but it appears that path is now clear and the need for future capital is gone.

The reason for this is that the Leer South project is due to be operating in Q3-2021 and this project, at current met coal pricing, is going to make a ton of money. The project is anticipated to generate 4 million tons of High-Vol-A coking coal a year for the next couple decades.

Right this very second (partially instigated by the trade war with Australia), prices to China are around US$300/ton. Indirectly, demand from China will continue to suck supply from other suppliers of the world.

Because shipping tens of thousands of tons of material is not an easy feat, transportation logistics became a ‘weighty’ issue. There is a limited capacity to transport from an eastern inland mining area (West Virginia) to the west coast (typically Long Beach, CA), and then onto a freighter across the Pacific Ocean. The opportunities for westward export are limited (indeed, Teck is making a fortune doing this from Elk River mines in southern British Columbia). As a result, the prices that ARCH will be receiving will be well less than US$300/ton, but it will be significantly higher than the averages received in 2019-2020.

High Vol-A, from what I can tell, is around US$190 spot currently. At that price, Leer South, once completed, will contribute an incremental US$500 million or so at existing pricing to the entity, in addition to the existing metallurgical operation. This is crazy amounts of money. Also, by virtue of the entire coal industry being decimated, competitors will have to take their time to open up more met operations (looking at Warrior Met Coal (NYSE: HCC) here), so Arch will eat up the lion’s share of marginal met coal dollars.

There is a lag effect between when coal is mined and when it is sold – contracts and deliveries have to be signed quarters and years in advance, so the pricing seen on GAAP statements will not be see until well after the economic substance of such transactions is actually performed. You can sort of see this being factored in the existing share price (which is the highest it has been since the Covid crisis) but my question will be what sort of valuation the market will ascribe to the company when they generate around $15-20/share next year (current analyst estimates are $7.63). Ultimately it depends on how much this boom for steel production (the primary driver of metallurgical coal consumption) continues world-wide.