Arch Coal Inc (NYSE:ACI) currently looks to be a contrarian value play in an unloved industry, but is the company a value trap? In this three part series, I’m going to take a look at both sides of the argument for and against the company’s suitability as a value play and attempt to arrive at a suitable conclusion.
Argument in favor of Arch Coal
Let’s start with the argument in favor of Arch Coal Inc (NYSE:ACI) as a value investment.
Why does Arch look attractive? Well, the company is cheap. In particular, at the end of the company’s fiscal third quarter, book-value-per-share stood at $12.06 and tangible book-value-per-share stood at $10.52. At present levels this indicates that Arch is trading at a tangible-book-value-per-share of 0.39 and a book-value-per share of 0.34.
That being said, Arch Coal Inc (NYSE:ACI) has not reported a profit for the last 12 months.
[drizzle]Still, Arch’s level of debt is not worrying and the company has plenty of headroom to fund a turnaround. At the end of the company’s third quarter, Arch reported total debt of $5.1 billion and cash of $1.4 billion; net debt of $3.7 billion. With total assets of $9.5 billion this gives Arch a net-debt-to-asset ratio of 39%.
However, this debt pile comes with a quarterly interest bill of approximately $95 million, which the company has not been able to cover with EBITDA for the last three quarters. What’s more, Arch has a net-debt-to-TTM-EBITDA ratio of 10.2x.
Nevertheless, the company remains liquid with total liquidity of $1.6 billion at the end of the third quarter, $1.4 billion of which was cash and equivalents, ($450 million is restricted cash tied a portion of the company’s senior debt). The company has no debt maturities to cover until August 2016.
With over a billion dollars of liquidity available to Arch Coal Inc (NYSE:ACI), the company does not appear to be in any financial trouble. Actually, thanks to asset sales, Arch has reported a net cash inflow of $91 million for the past 12 months, excluding debt issuance.
One of the major upcoming catalysts for Arch Coal Inc (NYSE:ACI) will be the company’s production from its Leer coal mine. Arch has invested $400 million to develop the Leer mining complex during the last four years, which produces a high-quality, high-volatile “A” coking coal product that is attracting significant interest in world metallurgical markets. The Leer mine uses a highly efficient longwall mining system, which, when in full production will give the company a very competitive cost-per-ton mine.
With this major investment out of the way and initial production already underway, Arch should see a boost to earnings in the near-term. However, it remains to be seen if this will be enough to get the company back on track.
So in summary, the case for Arch Coal Inc (NYSE:ACI) as a value investment revolves around three things. The company’s low valuation, CAPEX reaching inflection point and the initial production of the Leer mine, and Arch’s financial position, which infers that the company has plenty of liquidity to instigate a turn-around.
Part II – The argument against
However, there are currently a number of factors overhanging the company that could prove catastrophic to its turnaround. I’ll explore these factors within part two and three of this series; stay tuned!