November 29, 2012
Our Call Coal, Metals & Mining,
We believe US coal equities are oversold as investor sentiment rivals depths Engineering & Construction
of 2002's US power market despair. Despite suffering post-election blues, some Michael S. Dudas, CFA
encouraging signs supportive of gas, industrial production rebound in Asia and (646) 376-5329
additional global investment/output restraint should aid valuation. We continue to email@example.com
find shares underpriced and reflecting a much more onerous long-term thermal and Satyadeep Jain, CFA
met coal pricing and volume scenario. We would add to positions. (646) 376-5357
Thoughts on Price Action - Coal stocks in our coverage universe have dropped
nearly 20% on average since November 7, with JRCC and ANR down more
than 30%, while CNX losing 10%. We contend global macro factors have been Mentioned Companies:
Symbol Rating Price
dominating the coal trade, while industry fundamentals have not deteriorated in ACI Buy $6.47
recent weeks, and we find in some cases improving. We believe the elections ANR Buy $7.00
heightened "cliff" fears and more onerous regulation - events that could still impact BTU Buy $24.75
the sector. However, we note that international data surrounding coal continue CNX Buy $31.97
JRCC Buy $3.21
to strike a more positive, hopeful tone. Global coal mining majors continue WLT Neutral $28.46
to announce supply rationalization, and recent Chinese economic data appears
supportive for met coal demand.
Coal companies have accelerated financings to support focused free-cash goals
during 2013. We have viewed the equity sell-off as non-discriminatory for the most
part, not fully reflecting quality, liquidity and product mix differentials. Supportive
natural gas pricing, proactive capital and resource management, expected fiscal
and monetary improvement among emerging market economies that remain reliant
on imported thermal and coking coals and expected accommodative US monetary
policy should support coal equities into 2013. Among thermal oriented names,
we suggest Consol, Arch and James River, while Peabody and Alpha should
benefit from global economic recovery trends.
Re-election. The market will keep watch for additional EPA regulatory activity
targeting carbon and other particulate emissions. While new coal and industrial
plant targets preclude new coal plants, the risk would be if current operating
industrial and electricity plants could potentially face onerous emissions targets.
However, coal fired plant utilization remains below 60% with fleet potential in
the mid to upper 70s, allowing for ample room for demand growth if natural gas
pricing and spark spread/demand economics improve.
Trends Remain in Place - While near-term export flows face difficult comps and
little current pricing room, current US East, Gulf and other export capacity could
allow for a 40% improvement from current levels as European and Asian thermal
and coking coal demand recovers. Producers' 2013 operating and financial profiles
remain committed to a pullback in production, shutting down uneconomic output
and a continued sharp focus on capital preservation.
Recent Debt Financings - In the past few days, we have witnessed several
coal companies, including ACI, WLT and BTU, enhance liquidity and financial
flexibility by issuing/refinancing debt and/or modifying financial covenants. We
note that ANR and ACI had undertaken similar capital structure initiatives during
Q2. Even before these recent debt financings, we had estimated all coal companies
in our coverage universe had enough liquidity to survive through 2014.
Important Disclosures regarding Price Target Risks, Valuation Methodology, Regulation Analyst Certification,
Investment Banking, Ratings Definitions, and potential conflicts of interest begin on Page I of the Appendix Section.
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November 29, 2012
Recent measures undertaken by coal companies to enhance liquidity and financial flexibility indicate
a level of discretion and caution while preparing a solid war chest for the worst-case scenario, just in
case met coal prices remain sub $180/t and CAPP thermal coal prices sub $65/t though 2014. Most
US coal companies were already over-levered coming on heels of recent acquisitions at the top of
cycle in 2010-11. With these recent financings, leverage ratios for coal companies have swooned to
near all-time highs. The most recent debt issues have been expensive with yields to maturity nearing
or exceeding 10%. High fixed costs for companies in a cyclical/volatile industry can be burdensome.
However, we note that coal companies can prepay a part of this new debt if and when conditions
improve. We believe the market is underappreciating coal companies' long-term earnings power and
hence capital valuations and therefore expect the market to better reflect the liquidity and financial
flexibility to survive the current downturn, and emerge in a stronger position to enhance shareholder
returns when fundamentals improve during the next 12-18 months.
Capex Reductions - We expect 2013 capital expenditure for coal companies to be significantly
below 2011-12 levels. We believe it is imperative for coal companies to keep a close eye on cash
flow and liquidity in these market conditions, and are pleased to see management teams taking steps
in the right direction. Peabody has reduced its capital expenditure budget by $250 million since the
beginning of year, to $1.0-$1.1 billion. We would expect potential 2013 capital spending budget
targets could be significantly below current year levels. Arch expects 2013 capital spending at $350
million, $60-$80 million lower y/y. Alpha expects 2013 capex to be in the range of $300-350M
(including an LBA payment of approximately $45M) vs $450-$600M in 2012E. For Walter, we
expect capital expenditure of only $220M in 2013, a remarkable drop from almost $400M in 2012E.
Global Coal Production cuts - Anglo American (LON:AAL, GBX, 1695, NR) recently announced
its intention to scale back workforce at its Australian coal operations. Rio Tinto (RIO, $47.42, NR) is
targeting over $7 billion in spending cuts and savings, with the bulk of the cuts expected to be focused
on struggling aluminum and coal businesses. Xstrata (LON: XTA, GBX 1000, NR), BHP Billiton
(BHP, $71.25, NR) and other global majors have also announced such measures. Coal producers
all over the world have so far announced met coal production cuts of nearly 30-35 million tonnes
(MTPA) on an annualized basis, amounting to more than 12% of global seaborne market. At current
met coal prices, we believe more than 1/3rd of seaborne met coal production could be uneconomic,
leaving room for more production cuts if met coal prices do not increase from current levels. Thermal
coal producers have also intentionally (as a result of lower prices, higher taxes, labor, carbon costs)
or unintentionally (labor unrest in Colombia and South Africa) scaled back production. We believe
the global supply response, combined with renewed expectations of infrastructure spending in China,
could bring coal markets closer to balance in the near term.
Improvement in Chinese data - Recent Chinese economic data point to improvement. The latest
Chinese purchasing manager's index, industrial production, fixed asset investment, all show signs
of recovery. Chinese steel production reached 59.1 million tonnes in October, up 2% sequentially
and 8% y/y. Chinese hot rolled coil (HRC) prices have climbed from Sept 7 lows after government
announced plans to spend on infrastructure. Baoshan Iron & Steel Co. (SHA:600019, CNY 4.64,
NR), China's biggest publicly traded mill also raised prices for its cold rolled products recently, for
the first time in three months.
November 29, 2012
Regulation Analyst Certification:
I, Michael S. Dudas and Satyadeep Jain, hereby certify the views expressed in this research report accurately reflect my personal views
about the subject security(ies) or issuer(s). I further certify that no part of my compensation was, is, or will be, directly or indirectly,
related to the specific recommendations or views expressed by me in this report.
Sterne, Agee & Leach, Inc. makes a market in the following subject companies Arch Coal, Alpha Natural Resources, Peabody Energy,
Consol Energy, James River Coal and Walter Energy
Sterne, Agee & Leach, Inc.'s research analysts receive compensation that is based upon various factors, including Sterne, Agee & Leach,
Inc.'s total revenues, a portion of which is generated by investment banking activities.
Sterne Agee & Leach, Inc. expects to receive or intends to seek compensation for investment banking services from the subject company
and/or companies in the next three months.
Price Target Risks & Related Risk Factors:
Investment risks associated with the achievement of the price target include, but are not limited to, a company's failure to achieve
Sterne, Agee & Leach, Inc., earnings and revenue estimates; unforeseen macroeconomic and/or industry events that adversely affect
demand for a company's products or services; product obsolescence; changes in investor sentiment regarding the specific company or
industry; intense and rapidly changing competitive pressures; the continuing development of industry standards; the company's ability
to recruit and retain competent personnel; and adverse market conditions. For a complete discussion of the risk factors that could
affect the market price of a company's shares, refer to the most recent Form 10-Q or 10-K that a company has filed with the Securities
Methodology for assigning ratings and target prices includes qualitative and quantitative factors including an assessment of industry
size, structure, business trends and overall attractiveness; management effectiveness; competition; visibility; financial condition; and
expected total return, among other factors. These factors are subject to change depending on overall economic conditions or industry
or company-specific occurrences. Sterne, Agee & Leach, Inc., analysts base valuations on a combination of forward looking earnings
multiples, price-to-revenue multiples, and enterprise-value-to-revenue ratios. Sterne, Agee & Leach, Inc., believes this accurately reflects
the strong absolute value of earnings, the strong earnings growth rate, the inherent profitability, and adjusted balance sheet factors.
Additional company-specific valuation methodology is available through Sterne, Agee & Leach, Inc.
Definition of Investment Ratings:
BUY: We expect this stock to outperform the industry over the next 12 months.
NEUTRAL: We expect this stock to perform in line with the industry over the next 12 months.
UNDERPERFORM: We expect this stock to underperform the industry over the next 12 months.
RESTRICTED: Restricted list requirements preclude comment.
IB Serv./ Past 12Mos.
Rating Category Count Percent Count Percent
Buy 218 47.81% 18 8.26%
Neutral 220 48.25% 14 6.36%
Underperform 18 3.95% 0 0.00%
ADDITIONAL INFORMATION AVAILABLE UPON REQUEST: Contact Robert Hoehn at 1-212-338-4731.
Opinions expressed are our present opinions only. This material is based upon information that we consider reliable, but we do not
represent that it is accurate or complete, and it should not be relied upon as such. Sterne, Agee & Leach, Inc., its affiliates, or one or
more of its officers, employees, or consultants may, at times, have long or short or options positions in the securities mentioned herein
and may act as principal or agent to buy or sell such securities.
Appendix Section, Page I
November 29, 2012
Copyright © 2012 Sterne, Agee & Leach, Inc. All Rights Reserved.
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Appendix Section, Page II
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early years, our founders prominently established themselves in the financial securities industry in the southeastern United States. Today, we
have expanded to serve all regions of the country. Sterne, Agee is headquartered in Birmingham, Alabama with offices in 22 states. Sterne
Agee is one of the largest independent firms in the country. Sterne, Agee & Leach, Inc. is a division of Sterne Agee Group, Inc., which also
includes The Trust Company of Sterne, Agee & Leach, Inc.; Sterne Agee Asset Management, Inc.; Sterne Agee Clearing, Inc.; and Sterne Agee
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