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As the leading exporter of metallurgical coal from the U.S., ANR is pursuing opportunities to capitalize on tight global supplies and sustained buyer interest from a number of foreign countries. Strong global steel production, coupled with high ocean freight rates and weather and logistical problems encountered by Australian producers, has created opportunities for unplanned metallurgical coal sales overseas this year. China will continue to remain a large importer of coal as well as the country has a large supply of coal but lacks the necessary infrastructure to extract the commodity to meet demand.
Investment Thesis
•High Quality Reserves and Capacity to Meet Demand: ANR is a small-cap coal company with 70 mines and high-quality coal reserves. ANR is able to create extra value by blending coal qualities to meet client needs. ANR has low sulfur, high BTU coal. Approximately 82% of reserves are low sulfur reserves, with approximately 57% having sulfur content below 1.0%. Approximately 91% of total proven and probable reserves have a high Btu content which creates more energy per unit when burned compared to coals with lower Btu content. The company believes that our total proven and probable reserves will support current production levels for more than 20 years. Approximately 4 percent of ANR’s planned thermal production remains uncommitted for 2008 and approximately 58 percent is uncommitted for 2009.
•Catalysts: Catalysts include the continued increases in dry bulk shipping prices because of demand from emerging markets, and increased metallurgical coal prices due to favorable market conditions.
•Favorable Coal Market Fundamentals: Thermal coal prices will remain strong for at least the next three years, as demand from emerging countries continues and surging oil and gas prices cause some to turn to coal as a cheaper alternative. Based on various data sources, the company believes that a combination of reduced domestic coal production, higher net electrical generation by coal-burning utilities, reduced coal imports from South America and a surge in both met and thermal exports to Europe has led to a 40-45 million ton swing in the balance of coal supply and demand compared with last year, through mid-October. Supply growth is also expected to remain tight during the next several years, which will likely further boost prices. The market for met coal is widely expected to be robust in the near-term as well, as the industrial boom in countries including China and India drives demand. The company expects to price its coal in 2008 at around $48.
•Favorable Dry Bulk Shipping Market Fundamentals: The extent of the expected overseas coal boom can be gauged by the demand for dry bulk ships, which transport coal and other commodities such as iron ore and grain. As growth in emerging markets such as China and India accelerates, so does the demand for raw materials, which in turn drives up shipping rates. As dry bulk rates climb even higher, it becomes more vital for regions such as Europe and Brazil to import coal from closer to home, which gives U.S. companies the edge over traditional powerhouses such as Australia.
Valuation Based off of a valuation of the company’s reserves, I arrived at a target price of $38.00, using a conservative value of $27.00 as the mid-cycle price for metallurgical coal. I arrived at a price of $28.22 in my DCF base case, $18.00 in my DCF worst cast, and $29.00 in my DCF best case. Based on a comparable multiples analysis, I arrived at a price target of $36 in my base case scenario, $31 in my worst case scenario, and $38.00 in my best case scenario, arriving at an average price target based on comparable multiples of $35.00. Taking the average of these three valuation methods gives us a price target of $33.00.
Risks •Slow down in global industrial boom- A slowdown in the global industrial boom would send petroleum prices downward, thereby making coal less attractive, which would result in a decline in demand for coal. •Drop in dry bulk shipping rates- A drop in dry bulk shipping rates would hurt Alpha Natural Resources because buyers would no longer view American coal as a cheaper alternative to other regions, a key element to my investment thesis. •Over supply of coal- As coal prices continue to increase, the attractiveness to mine for coal increases for new entrants and incumbents. As a result, an excess supply of coal could come online, eroding ANR’s margins. If substantial supply ever comes online in China, which has a significant amount of coal reserves but lack of infrastructure to extract its reserves, the price of coal will likely drop. •Environmental regulation- Coal contributes to global warming and is seen as an unclean source of energy. Any passing of carbon legislation would likely decrease demand for coal.
Management
Alpha Natural Resources is headed by Mr. Michael Quillen, who is 58 years old and serves as chairman and CEO, and has strong experience in the coal industry. From September 1998 to December 2002, Mr. Quillen was Executive Vice President Operations of AMCI Metals and Coal International Inc., a mining and marketing company, where he headed an initiative to develop AMCI’s Australian properties. He has held senior executive positions in the coal industry throughout his career, including as Vice President Operations of Pittston Coal Company, President of Pittston Coal Sales Corp., Vice President of AMVEST Corporation, Vice President Operations of NERCO Coal Corporation, President and Chief Executive Officer of Addington, Inc. and Manager of Mid-Vol Leasing, Inc.
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