Alpha Metallurgical Resources: The ‘Fat Pitch’ You’ve Been Waiting For (NYSE:AMR)
Alpha Metallurgical Resources (NYSE:AMR) is the largest domestic producer and exporter of metallurgic coal and also produces some thermal coal. The firm has enjoyed substantial success from the recent surge in coal prices despite production remaining flat. While coal prices may remain volatile in the coming months/years there exists a large margin of safety with a pristine balance sheet of essentially zero gross debt, a management team focused on returning capital to shareholders, and a business with an EV of $1.8B that will do close to $1.5B in FCF.
State of the Coal Market
The popular thought across the masses is that coal is a quickly dying industry. However, for better or for worse that couldn’t be further from the truth. The globe depends on coal for a variety of things including steel production and heating power.
The International Energy Agency (IEA) recently released a review of the coal industry in 2022 and provided forecasts until 2025.
Some highlights included:
1. Coal is the largest energy source globally for electricity generation and for the production of iron and steel.
2. It is also the largest single source of carbon dioxide emissions.
3. Global coal consumption is set to plateau through 2025 and could grow thereafter.
4. Despite record profits for producers, there is little appetite for more investments in coal mining assets.
5. Met coal consumption is expected to remain stable through 2025.
6. Global coal supply hits an all-time high in 2022 but is expected to stall by 2025.
7. American coal producers struggle to ramp up coal production despite high coal prices.
All of these facts, in my opinion, indicate that the coal industry is here to stay for the foreseeable future and at this price it’s very hard to ignore the FCF that AMR can generate during the next few years.
Additionally, China has just released a memo reiterating its focus on coal to “quicken approval of new coal projects” to ensure energy supply. This is massive for the industry as it opens up the Chinese market, who is the largest consumer of coal.
Lastly, as per recent analysis from S&P Global, they expect to see tight supply coming out of China because of a rainy season: “Wetter than average January to March for eastern Queensland forecast by Australia’s Bureau of Meteorology could lead to a third consecutive year of supply disruption from Australia.” As a result we are seeing a big spike in pricing:
As you can see coal producers like AMR should not be priced like they only have 1 year of profitability left. Coal still plays a massive part in power generation across most developed economies, and it will take years and years of investment and innovation of clean power to be phased out. Developed and developing nations are not going to give up power.
Furthermore, On 11/28 Alpha provided 2023 guidance that stated that shipment volumes should come in between 16.4-17.8 million tons which is, taking the midpoint, is a 7% increase over 2022. This is showing that they expect to continue to grow in the coming year.
AMR also stated that their ~30% of their volumes for 2023 are already contracted at $193 for met coal and 130 for thermal coal.
Management did also guide higher on the cost side of the equation, but this should be offset by the increase in volume.
Lastly, management stated: “We are encouraged by the continued demand in coal markets, and expect supply to remain tight across the globe for some time to come, we believe Alpha is well positioned to ship more coal in 2023”.
In my opinion this guidance is conservative. There are many things that could help them to exceed guidance, like seaborne coal getting stuck at sea again or weather, or LNG plants not getting turned on as quickly as possible. However, I do appreciate management settings expectations and being conservative. Most importantly, management expects to grow, which is not how this stock is being priced, adding to the attractive risk/reward profile.
Management is extremely focused on returning capital to shareholders. The company has increased its dividend for the past 3 consecutive quarters and just paid a one-time special dividend of five dollars per share.
Prior to institution the dividend the firm eliminated their debt. This massively de-risks this company and will allow them to return capital to shareholders.
Additionally, the company is in the middle of a $1 Billion dollar share buyback program and has only completed $452 million as per 10/31/2022 . Yes, you read that correctly, a company with a market capitalization of less than 2.5 Billion, a net cash position, and exploding Free Cash Flow, is buying back 40% of their shares. If that isn’t an attractive risk reward, or the fat pitch you’re waiting for I’m not sure what is.
Below is an excellent slide from their investor presentation highlighting this:
I believe the biggest risks include:
1. Coal prices rapidly decreasing to below cost of $110
- I believe this is unlikely due to coal demand staying high and supply staying low.
2. Geopolitical tensions escalate and there are trade restrictions placed into key markets like China and India.
- I believe this is the biggest risk. If there is a massive global recession and the need for power generation decreases and trade stops AMR would be hurt, but so would all equities.
3.Inflationary costs (mostly labor and supplies) increase and costs go up dramatically.
- It seems like wage inflation is beginning to peak so I think costs are starting to level.
4. Regulatory risk if policy makes more restrictions around coal emissions.
- Given that AMR’s customer base is geographically diverse I don’t see this being an issue for them.
5. ESG investment continues to limit investment in the coal industry.
- In my opinion this is one of the reasons this mispricing exists. It is because large institutions are limited from investing in this industry or don’t want to be seen as supporting this industry.
AMR’s risk/reward proposition is extremely attractive. How often can you get a company trading at 1x earnings expected to do 1.5 Billion in free cash flow in the following year? The risks can easily be offset with all of the positive and conservative expectations for the following year. If the demand for coal stays as is the company is going to eat itself (buyback all shares) within just a few years. Even without any multiple expansion this company could easily double. Using DCF analysis with, in my opinion, conservative assumptions, which include a high WACC, 3.3x EBITDA, and negative growth of FCF we can see that there is 43% upside from shares. The risks can easily be overcome by the cheap valuation, the upside potential, and growth.