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Arch Coal Inc. (ACI - Analyst Report) reported pro forma earnings per share of 20 cents in third-quarter 2012, significantly beating the Zacks Consensus Estimate of a loss of 15 cents per share. Quarterly results were also higher than the year-ago earnings of 3 cents per share.

Arch Coal’s growth in quarterly earnings was driven by a decline in its cost of operations including reduction in depreciation, and selling, general and administrative expenses.

The company’s third-quarter 2012 GAAP earnings were 22 cents compared with 4 cents in the prior-year quarter. The variance between quarterly pro forma and GAAP earnings was due to a gain of 2 cents for amortization of acquired sales contracts, a penny gain associated with mine closure and asset impairment, and tax adjustment charge of a cent.

Total Revenue

Arch Coal's total revenue in the reported quarter was $1,087.6 million, down from $1,198.7 million in the year-ago quarter. Quarterly revenue fell short of the Zacks Consensus Estimate of $1,033.0 million.

The company’s third-quarter 2012 revenue decreased primarily due to a decline in average sales price per ton to $25.57 from $27.87 in the year-ago quarter. This was partially offset by an increase in shipments in Arch Coal’s western operating regions.

Operational Update

Arch Coal sold 37.5 million tons of coal in third-quarter 2012, down 6% from the year-ago level of 39.9 million tons. This decrease in sales volume resulted from sales volume decline in Powder River Basin (“PRB”) and Appalachia; partially offset by an increase in sales volume at Western Bituminous Region.

The company’s adjusted earnings before interest, tax, depreciation and amortization (“EBITDA”) in third-quarter 2012 were $256.5 million, up from $211.5 million in the year-ago period.

Interest expenses were $74.3 million at the end of the third quarter of 2012 compared with $76.9 million in the prior-year period.

Financial Update

Cash and cash equivalents of the company as of September 30, 2012 were $550.8 million versus $138.1 million as of December 31, 2011.

As of September 30, 2012, Arch Coal’s long-term debt was $4.5 billion compared with $3.8 billion as of December 31, 2011.

In the first nine months of 2012, the company’s capital expenditure was $304.0 million compared with $215.9 million in the prior-year comparable period.

Guidance

In 2012, Arch Coal expects to sell 129 - 135 million tons of thermal coal and 7.5 million tons of metallurgical coal.

Selling, general and administrative expenses are expected to be in the range of $125.0 - $135.0 million in 2012.

Interest expenses are expected to be in the range of $300.0 - $310.0 million in 2012.

For full-year 2012, the company’s capital expenditure will likely be in the range of $410.0 - $430.0 million.

Peer Update

Arch Coal's primary competitor, Peabody Energy Corporation (BTU - Analyst Report) announced its third-quarter 2012 operating earnings of 51 cents per share compared with 90 cents per share in the year-ago quarter. Its quarterly earnings beat the Zacks Consensus Estimate of 34 cents.

Peabody’s third-quarter 2012 revenue was $2,058.8 million versus $1,980.6 million in the prior-year quarter. The reported revenue surpassed the Zacks Consensus Estimate of $1,975.0 million.

Our Take

We have observed that Arch Coal continues to follow several cost reduction measures including idling of three of its mines in Appalachia to manage current market demand. The company also plans to reduce its capital spending on low return units. These initiatives will enable the company to improve its forthcoming financial as well as operation results.

In addition, Arch Coal intends to expand and develop its low-cost asset portfolio by constructing the high-quality Leer metallurgical coal mine in the region. The company expects Leer mine to contribute substantially to its top line in future.

However, we believe that these growth opportunities could be challenged by softened global and U.S. coal demand, which will influence Arch Coal’s financials in the following quarters. Secondly, increasing substitution of coal with natural gas could drive down coal prices while impacting the company’s margins.

Arch Coal Inc. currently has short-term Zacks #3 Rank (Hold rating).

St. Louis, Missouri-based Arch Coal Inc. engages in the production and sale of steam and metallurgical coal from surface and underground mines located in the United States. With a market capitalization of $1.77 billion, Arch Coal has 7,442 full time employees.

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