"The bad news, though, came from the rails. Ongoing rail disruptions in the Western U.S. cost the company nearly 4 million tons of coal from the Black Thunder mine. Tallying it all up, management estimates that the rail problems cost the company about $0.35 a share in profits."
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Rails Derail Arch Coal
By Stephen D. Simpson, CFA
July 25, 2005
In principle, coal mining should be a pretty simple affair. Find coal, dig coal, ship coal, and use the money to find more coal. Rinse and repeat. Well, simple is all well and good until one of the basic ingredients breaks down. In this case, shipping coal out of the Powder River Basin proved to be more challenging in the second quarter, and Arch Coal (NYSE: ACI) paid the price.
On the surface, Arch Coal had all the makings of another great quarter. Demand for coal continues to outstrip supply, prices for Powder River Basin coal have been soaring, and Arch Coal's contracts continue to roll over for renewal.
Revenue for the quarter rose 50%, and the company's volume of coal sold swelled by 31% -- to well in excess of 34 million tons. What's more, on a per-ton basis, the company reaped 12% more in pricing.
The bad news, though, came from the rails. Ongoing rail disruptions in the Western U.S. cost the company nearly 4 million tons of coal from the Black Thunder mine. Tallying it all up, management estimates that the rail problems cost the company about $0.35 a share in profits.
Hopefully, this will be just a temporary problem. After all, ongoing rail issues aren't in anyone's interest -- not the coal companies, not the utility companies, and certainly not the railroad operators themselves. Consequently, I would expect operators like Union Pacific (NYSE: UNP) and Burlington Northern (NYSE: BNI) to be working hard to get their ducks back into a row so they can restore normal service. Still, it wouldn't surprise me if it were to take the rest of the year for matters to get back to normal.
Rail issues aside, there is still much to like about Arch Coal. New lower-cost production is coming online and Arch has considerable coal reserves. Much of that coal is attractive from a pollution standpoint -- meaning it's relatively clean and largely meets or exceeds current pollution standards. Many of Arch's contracts will expire in the next few years, allowing the company to re-up them at much higher prices. Finally, the overall market for coal still looks robust; this has been a warm summer so far and utilities are digging deeper into coal inventories that are already lower than they should be.
It's never a lot of fun to try to value cyclical companies like Arch Coal. Oftentimes, you have to go against the normal rules of thumb, buying when things look expensive and selling when it looks cheap. Nevertheless, coal prices are quite high now, and companies like Arch Coal -- as well as rivals like Peabody Energy (NYSE: BTU) and Massey Energy (NYSE: MEE) -- can probably look for another two to three years of strong pricing before production could catch up and allow customers to rebuild inventories.
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