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Risk-Reward Balanced at Arch Coal

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On March 25, we have issued an updated research report on Arch Coal Inc. . The U.S. coal major continues to expand its coal reserve and focus more on cost-containment activities. However, stringent environmental regulations and over-dependence on limited customers for revenue generation can challenge the company’s growth trajectory.

Arch Coal, a Zacks Rank #3 (Hold) stock, reported adjusted loss per share in fourth-quarter 2013, which was wider than the Zacks Consensus Estimate and the prior-year level. Quarterly result was negatively impacted by a decrease in revenues and higher interest expenses. The company’s fourth-quarter total revenues missed the Zacks Consensus Estimate. On a year-over-year basis, reported revenues decreased mainly due to lower sales volumes and a drop in average sales price per ton.

In 2014, metallurgical (met) coal demand is expected to increase primarily due to higher steel production. As per a World Steel Association report, the use of steel will likely increase in 2014, primarily due to higher demand in China, India, Japan and the Middle East and North African region. We believe Arch Coal’s sufficient met coal reserves along with the commencement of production from its Leer mine in Tygart Valley will enable the company to meet increased coal demand.

We appreciate Arch Coal’s steady cost-containment initiatives. In 2013, the company’s total operating costs and expenses decreased 18.7% year over year, primarily on the back of lower cost of sales. In addition, Arch Coal is right-sizing its operations, reducing consumable costs for diesel and explosives, and curtailing contractor and overtime labor costs. These initiatives will enable the company to improve its future margins.

However, Arch Coal may face stiff competition from Australia and Indonesia due to their growing dominance in coal export market. The coal companies of these countries enjoy lower transportation cost compared to the U.S. owing to their proximity to the Asian countries, which can help them to win significant coal contracts from India and China.

Key Picks from the Sector

Other better-ranked stocks in this sector include Rhino Resource Partners LP , Westmoreland Coal Company (WLB - Free Report) and Oxford Resource Partners, L.P. . While Rhino Resource Partners carries a Zacks Rank #1(Strong Buy), Westmoreland Coal Co. and Oxford Resource Partners hold a Zacks Rank #2 (Buy).

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