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Alpha Metallurgical: This coal miner definitely has more to offer us

Jamie Cameron
27. 8. 2022
6 min read

The price and demand for coal is at high levels this year, which is evident in the performance of Alpha Metallurgical Resources $AMR+1.2%. The company has already seen really strong growth, but looking at the increased forecasts and the future outlook, it may not be that significant. Of course, we have to take into account that this is a cyclical stock that has already shown us a lot this year, but that doesn't change the fact that the company still has a lot to offer.

Alpha Metallurgical Resources is a leading coal supplier with underground and surface coal mining complexes.

Alpha Metallurgical Resources is a Tennessee-based coal mining company with operations in Virginia and West Virginia. The company's portfolio of mining operations consists of underground mines, surface mines and coal preparation plants. It produces low-ash metallurgical coal that is supplied to domestic and international coke and steel producers. The Company's reportable segments are Met and CAPP - Thermal, with key revenues coming from the Met segment.

In a word, brutal. That's how I would describe the performance and coal price chart respectively.

After years of capital starvation and underinvestment, both metallurgical and thermal coal are having a ''moment'' of glory and attention. Coal prices have reached an all-time high over the past 18 months and remain extremely high compared to historical averages. Despite this boom in the underlying commodity, however, the story of major US producers remains interesting. In particular, the story of Alpha Metallurgical Resources $AMR+1.2%.

Potential

The first impression of most investors could be summed up as follows: Yes, it's extremely cheap on a P/E basis, but it's a commodity producer (P/E of 2.42). It has boom and bust cycles. What makes this situation different? As it happens, cyclical stocks don't exactly have a juicy period in times of crisis and recession, you can look at giants like Vale and Rio Tinto, which are currently experiencing losses. But how is AMR different?

  • In the current price environment, it generates a lot of cash flow . In Q1, AMR sold 3.78mm tonnes of met-coal (metallurgical coal) at an average price of $240. Their margin on those tons after all costs was $137, resulting in EBITDA of $513 million for the quarter. For shareholders, that meant $20.52 in EPS in the first quarter and $29.97 in the second (+3000% compared to last year).

Supply and demand outlook

Let's first touch on the demand side. As you probably know, steel is one of the main pillars of the industrial economy. Modern economies could not grow or even function without the constant consumption of steel. It is needed for everything from buildings, cars, appliances, reinforced concrete, pipelines, even wind turbines. In 2021, 1.95 billion tons of steel was produced and about 2/3 of that steel production is "virgin new" rather than recycled steel. Producing 1 net new tonne of steel requires about 0.9 tonnes of high quality coal.

We need a lot of coal to make all the things a modern economy needs. As the developing world grows economically richer, they will need more steel. Unless the decades-long trends of economic growth and urbanization are reversed, the demand for steel is in secular growth.

  • After a year of sluggish growth in 2022 (0.4%), the World Steel Association predicts that steel demand will resume its upward trend and grow by 2.3% in 2023. That's starting to look good, don't you think?
  • And the U.S. domestic market (EIA) forecasts that coal demand will grow 8% from 2021 to 2023.

What's in the company's cards?

The biggest coal exporters are the US, Australia and Russia. Because of sanctions, Russian supplies will not find their way to the Western world anytime soon. In the US, the supply response has been muted. This can be partly blamed on ESG investment mandates that have left the coal industry starving for years, resulting in minimal new mine development.

Return on capital

In this environment, the company is generating insanely high FCF returns that will stretch well into 2023. This creates a huge opportunity for the company to buy back shares. This is the only responsible way to deploy capital currently.

AMR management has been very clear about its plan to allocate excess FCF to share buybacks. In addition to paying off the entire balance of its term loan and successfully reducing its debt in recent months, AMR has expanded its buyback program to $600 million.

  • 126 million of that buyback has been used through June 3 at an average price of $146.

In addition to an annual dividend of less than 1%, you can be sure that management will use most of the excess cash to buy back shares. I think AMR management's clear stance on buybacks is one of the best reasons to own it in the current operating environment.

Pros and cons of the investment

Pro

  • This machine is generating high FCF and so far there is no indication that demand for coal and steel will fall anytime soon (on the contrary, I see room for even higher prices).
  • The amount of cash the company in quotes doesn't need, so it is happy to use it for buybacks, which will push the stock even higher.
  • The lifting of sanctions imposed on exports from Russia are in sight.
  • Overall, coal is gaining more attention as winter approaches and the world begins to look at it with its old monotonous gaze.
  • The company is increasing its guidance for thermal by-product shipments in the Met segment to a range of 1.0 to 1.4 million tonnes, up from the previous guidance range of 0.8 million tonnes to 1.2 million tonnes. This adjustment also slightly increases the estimate of total shipments to a range of 15.6 million tonnes to 17.2 million tonnes, from the previous range of 15.4 million tonnes to 17.0 million tonnes.

We don't know much about analysts' forecasts, as this company doesn't cover many of them. So I wouldn't completely focus on the forecasts.

Versus

  • A cyclical stock where it may look like the cycle has peaked.
  • Currently, it may seem overpriced to investors.
  • Demand is holding high, but no one can say for sure how the overall market and commodity market will continue to perform.
  • Macroeconomic headwinds and a possible recession, this is where I see the biggest stumbling block and take it as the current biggest risk.

Conclusion

In summary, AMR presents a definite risk/reward opportunity for the investor. It produces a commodity that is essential to the modern world and of which there is a shortage. It has high-quality assets that will perform for decades and generates plenty of FCF. The aggressive share buyback strategy continues and should continue. But as I write - it can seem expensive and I remind you again and again that this is a cyclical stock that can experience a drastic downturn in a recession. I write about the stock because of the potential it continues to hold, yet this is not a complete analysis and an investor must take a fairly large risk here (this is my initial impression of a company in which I do not currently have an open position).

Please note that this is not financial advice. Every investment must go through a thorough analysis.

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