Is Arch Coal a Steal Here?

With shares of Arch Coal Inc. (NYSE:ACI) trading at around $6.01, is ACI an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

coalC = Catalyst for the Stock’s Movement

Let’s get all of the bad news out of the way first. The earnings report was no doubt an unmitigated disaster. The stock fell 12.84 percent after the news was released. Then we have industry competitors that are fighting tooth and nail for market share in a weak industry. On top of that, natural gas is making a move, and solar isn’t far behind. Over the past eight years, there has been a significant drop in coal-generated electricity. This trend certainly won’t reverse itself within the next four years because President Obama is fairly anti-coal (for environmental reasons). If that’s not enough bad news, Arch Coal has poor margins, many analysts don’t like the stock, the stock has performed poorly in a strong market, and there is a 20 percent short position on the stock. So…what could possibly make this a good investment?

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The answer to that question can be summed up in one word, but as you might have guessed, that word won’t be revealed yet. After all, what’s a good story without any suspense? For now, let’s look at smaller bits of good news, which are solid cash flow, an increased cash and liquidity position to $1.4 billion as of December 31, 2012, record performance last year delivered by the Western Bituminous region, and the expectation of metallurgical sales volume growth in 2013.

Now let’s take a look at some important numbers for Arch Coal prior to forming an opinion on the stock…

E = Equity to Debt Ratio Is Weak

The debt-to-equity ratio for Arch Coal is weak — weaker than the debt-to-equity ratios for Peabody Energy Corp. (NYSE:BTU) and Alpha Natural Resources (NYSE:ANR).    

Debt-To-Equity

Cash

Long-Term Debt

ACI

1.45

$650.11 Million

$4.58 Billion

BTU

1.27

$558.80 Million

$6.25 Billion

ANR

0.59

$549.40 Million

$2.99 Billion

 

T = Technicals on the Stock Chart Are Weak 

Arch Coal has underperformed the market over the past three years. However, this is an industry-wide trend.

1 Month

Year-To-Date

1 Year

3 Year

ACI

-21.21%

-17.55%

-60.71%

-69.64%

BTU

-11.64%

-9.55%

-35.85%

-41.11%

ANR

-18.40%

-13.04%

-62.82%

-79.43%

 

At $6.01, Arch Coal is currently trading below all its averages. 

50-Day SMA

7.17

100-Day SMA

7.21

200-Day SMA

7.11

 

E = Earnings and Revenue Have Been Inconsistent          

Arch Coal reported a significant drop in earnings in 2012. However, revenue only saw a modest decline. Revenue had been increasing consistently on an annual basis from 2009 to 2011.

2008

2009

2010

2011

2012

Revenue ($)in billions

2.98

2.58

3.19

4.29

4.16

Diluted EPS ($)

2.45

0.28

0.97

0.74

-3.24

 

When we look at the last quarter on a year-over-year basis, we see a decrease in revenue and EPS.

12/2011

3/2012

6/2012

9/2012

12/2012

Revenue ($)in billions

1.23

1.04

1.04

1.06

968.23M

Diluted EPS ($)

0.32

0.01

-2.05

0.22

-1.39

 

T = Trends Do Not Support the Industry

The biggest factors working against the industry is the emergence of natural gas and solar as more significant sources of energy, which have led to the significant drop in coal-generated electricity over the past eight years, as well as burning coal leading to acid rain, safety concerns for workers, and President Obama. So, once again… what could possibly make this a good investment?

Conclusion

The word is exports. China is the biggest factor. This is a fast-growing country with fast-growing energy needs — it’s a prime target for affordable coal, especially considering is environmental laws are much less stringent than in much of the Western world. What many people don’t realize is that India is also growing at a rapid pace, and there will be just as much potential there when it comes to coal.

Trends do not support the industry at the moment, and the entire group has been selling off as if it has been selling poison. However, it’s highly unlikely that the entire group will simply disappear. There is still plenty of demand for coal around the world, and in some places, that demand is increasing. One popular Wall Street saying is that you should buy when there’s blood in the streets. Well…there’s blood in the streets. In this case, it’s actually more like blood, limbs, and guts.

Watch this group carefully. It will eventually bottom, and when it does, it could end up being a great investment opportunity. Presently, Arch Coal is a WAIT AND SEE as the industry hasn’t bottomed yet. It could take a while, but this stock and the group as a whole should be kept on any investor’s radar.

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