Introduction
A little more than a year ago, I published an article recommending the stock of Warrior Met Coal (HCC). The stock has done well, nearly doubling along the way to its peak, and still up about 50% after a recent pull-back. Today, I am recommending a similar company, Alpha Metallurgical Resources, Inc. (NYSE:AMR). I believe that a recent drawdown in the stock offers an opportunity for investors, as the negatives of being in a disliked industry are outweighed by the attractive financials and growth opportunity from greater steel usage in the world.
Company background
Alpha Metallurgical is headquartered in Bristol, Tennessee, although its mines are in Virginia and West Virginia. It is a producer of metallurgical coal, used in steel-making, with a small amount of byproduct revenue (3%) from thermal coal, used to produce electricity. 80% of its revenue comes from exports (primarily to India and Brazil), and 20% from domestic sales.
The company has 316 million tons of proven and probable reserves, approximately twenty years at the current rate of production.
In March 2024, a container vessel departing Baltimore Harbor lost steering control and struck one of the main support piers of the Francis Scott Key Bridge, causing it to collapse. Many coal companies were affected by the subsequent shut-down (since reversed) of the coal terminal in the harbor. Alpha was not directly impacted, since it does not utilize that terminal. It primarily exports from a 65% owned terminal in Newport News, VA.
For an overview on the types and usages of coal, please refer to my prior article on HCC.
The state of the steel market
Over the last few months, higher interest rates have taken a toll on the global industrial economy, with weakening demand for steel. In addition, numerous elections across the world have created economic uncertainty. Although steel production has been flat YoY, prices along the chain, including for metallurgical coal, have softened. It remains to be seen if this trend will be reversed by pending interest rate reductions in the US and Europe.
Building and infrastructure accounts for the largest use of steel worldwide, with automotive following behind. China’s property sector has been in the doldrums, while office property development worldwide is suffering from the work from home trend. Subsidies are spurring manufacturing onshoring in the US, providing a bright spot. Auto production had a catch-up burst after COVID-19’s supply chain snarls, but has now leveled off, as demand has been hit by high interest rates.
Alpha Metallurgical financial overview and outlook
Alpha’s latest quarter was disappointing, primarily due to lower coal prices and increased costs. For the quarter ending June 30, 2024, the company reported $804 million in revenue (down 6% YoY) and $71 million in operating income (down 67% YoY). Diluted EPS came in at $4.49. The company ended the quarter with $336 million of cash and $9 million of debt. Thus, it had net cash of $25 for each of its 13 million shares.
The cash flow statement showed nothing amiss, with capital expenditures modestly higher than depreciation. The company spent about half its free cash flow buying back stock, with the rest added to its cash balance. In fact, over the last year, the company has taken out 10% of its share count through buybacks.
In 2024, the company is expected to earn $22 per share, going up to $31 per share next year as conditions improve. I believe these estimates are achievable in a stable economy.
The company has a market capitalization of $2.6 billion and an enterprise value of $2.3 billion, representing 0.7x revenues.
AMR valuation: Fair value of $300
I will apply a conservative below market 10x multiple on 2025 EPS to value the stock at $300. Thus, the stock offers 50% upside from the current $194 price. While this may seem like plenty of upsides, the stock was at this level just two months ago!
In a bear case, a global recession will cause coal prices to fall and the company’s earnings could come in much lower. In this scenario, the company may earn only $15 per share, and a similar 10x multiple would result in a share price of $150, for 25% downside.
I will not offer a bull case, since the base case is bullish enough!
I recommend the stock to those unburdened by ESG considerations. Given the high volatility in the stock, the return can be enhanced by selling covered calls at the $300 strike price.
There has been some recent M&A in the space, with Arch Resources (ARCH) and Consol Energy (CEIX) agreeing to merge. Alpha could be a participant if this trend continues.
Risks are high
Buying any commodity company is high-risk, since the company has no control over the pricing of its product. Although purchase contracts can ameliorate some of this risk, the value of the company is dependent on where prices head in the long term. So the biggest risk here is that the company’s earnings will come in lower than expected due to a decline in the price of metallurgical coal.
As a miner, the company is exposed to the risk of a catastrophic accident at one of its mines. It is also subject to various regulations, and there is a chance these may become more onerous.
With operations in the US and exports to the rest of the world, the company is exposed to geopolitical risks, including the imposition of tariffs and the disruption of shipping.
The company depends on its employees doing a dangerous job, and needs to maintain good labor relations. It is possible that the company will face increasing costs going forward.
Conclusion
An investment in AMR offers good potential upside, leveraged to steel demand, with above-average risks. The company’s net cash position offers some downside protection.
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