Alpha Metallurgical Resources (AMR)

Summary & Back of the Napkin Proforma

Sep 21, 2021

Intro

Alpha Metallurgical Resources, ticker symbol AMR, is a met coal producer which operates both underground and surface mines in the Central Appalachia (CAPP) coal basin. AMR is headquartered in Bristol, Tennessee and has 5 mining operations in Virginia, and 15 in West Virginia.

Mines in CAPP take on a reverse hub and spoke distribution model whereby the mines produce run of mine (ROM) coal which is sent to centrally located preparation plants which wash and blend the coal into a clean product for sale and shipment. Alpha generally has multiple mines, or spokes, feeding the prep plants, which can be thought of as the hubs. The prep plants also have rail loadout facilities and are therefore the free on board (FOB) point of sale for each mine.

The mines and prep plants are listed in the slide below, taken from AMR’s latest investor presentation:

Before we discuss the details, I feel it’s pertinent to grasp the history involved with Alpha.

History

The former Alpha Natural Resources (ANR) was primarily the result of two mergers, one of Foundation Coal in July 2009, and the second of Massey Energy in January 2011 following the Upper Big Branch mine disaster. After the merger, ANR owned or operated upwards of 110 to 150 mines. Compare that to the 20 in production today and you get a sense for the scale of what used to be.

Alpha Natural Resources suffered four straight years of losses and subsequently filed for bankruptcy on August 3, 2015. The timing of the $7.1 billion paid for Massey could not have been worse. The industry almost immediately began to retreat, a classic example of overspending being correlated to future underperformance. Alpha laid off 4,000 workers and closed all but 50 mines. They emerged from bankruptcy in 2016 by splitting into two separate entities; one with all of the worst mines and bad assets, and Contura, which held all of the choice assets.

In December 2017 Alpha sold their Powder River Basin (PRB) assets to Blackjewel (whom later filed for bankruptcy, which caused some blowback). Then, in December 2020, Alpha sold their thermal operations located in Pennsylvania, effectively removing themselves from the thermal side of the business. These divestitures, with hindsight, can also be characterized as “bad timing”, given today’s high natural gas prices and global demand for thermal coal.

Contura Energy then changed its name to Alpha Metallurgical Resources on Feb. 1, 2021. They marketed the rebranding effort as the company’s exit from the thermal coal business, but that’s just ‘spin’. It was really just to get back to their original “Alpha” roots.

Mines & Coal Quality

The annual report doesn’t really give us much detail on mines or coal quality, so we will have to infer a bit based on my knowledge and the following table:

As discussed above, it’s easier to track overall product volumes on a prep plant basis. Therefore, let’s discuss each one and infer the coal type, quality and customer:

Marfork: mostly a mix of High Vol-A and High Vol-B, although mostly the HVA variety; mostly (~60%) sold to domestic customers on annual contracts.
Mammoth: mostly High Vol-A; sold to domestic customers (inferred - could be wrong).
Kingston: high quality High Vol-A; sold entirely to domestic costumers on annual contracts.
Kepler: mostly a high quality Low-Vol sold predominately (~95%) to domestic customers on annual contracts.
Power Mountain: predominately High Vol-A; mostly marketed to export customers.
Bandmill: mostly a mix of High Vol-A and High Vol-B, although mostly HVB variety; marketed primarily to export customers.
McClure: mostly a mix of High Vol-A and High Vol-B, some mid-vol’s; marketed primarily to export customers.
Toms Creek: mostly a mix of High Vol-A and High Vol-B, some mid-vol’s and some thermal; met portion marketed primarily to export customers.

The overall mix is “well balanced” even though HVB is not desirable compared to HVA, for example, and their mid vol’s may not be the top tier/premium variety, but the pie charts below give you a good feel for the mix:

The export to domestic sales ratio at 70:30 is important. Having significant export optionality is a competitive advantage which produces superior pricing power in periods of strong demand. Domestic sales are also valuable since they provide inherent hedging options due to their annual fixed-price contract characteristics. A producer with a good mix of both export and domestic sales operates in a sweet spot, allowing them to optimize volumes and sales prices in most environments.

Alpha’s slide highlights that they’re the largest met producer, and most diversified from a mine standpoint. I think that point is well taken, but perhaps offset by the fact they don’t have any big low cost longwall mines. Their cash costs have improved since early 2019, from $90/ton to approx. $70/ton, despite being predominately room and pillar based. But the operating leverage, in terms of ramping up production from a longwall system, is definitely missing from their asset base.

Transportation & Port Access

Export sales are primarily shipped via rail to Dominion Terminal Associates (DTA) and Pier 6, located on the east coast in the port of Hampton Roads at Newport News, Virginia. In March 2017, Alpha increased their stake in the DTA coal export terminal from 40.6% to 65% (with the remaining shared interest owned by ARCH). DTA provides Alpha with 14.3 million tons of export capacity. and is serviced by the CSX railroad (ticker CSX) which delivers unit trains, and is combined with ground storage capacity of 1.7 million tons (1.1 million attributable to Alpha). Coal is segregated in storage areas by coal type and shipper. Seagoing vessels of up to 177,000 DWT can be accommodated on either side of a 1162 foot pier, and both berths are dredged to a water depth of 50 feet to match the harbor channel.

Here’s an image of DTA:

In contrast to DTA, which is serviced by CSX, Pier 6 is serviced by the Norfolk Southern (NS) railroad, ticker NSC. Pier 6 is located at Lamberts Point on the Elizabeth River in Norfolk, Virginia. The annual throughput capacity is 48 million tons, but this includes thermal and met volumes whereas DTA is met only.

Here’s a map of Norfolk, Virginia with coal terminals circled in red:

Strategy

During the summer of 2019, Alpha’s management team went through a transition of sorts with David Stetson, Scott Kreutzer, and Jason Whitehead taking the reins. Since then Alpha has been on a cost cutting mission, idling contractor mines, and finding ways to lower expenses. They’ve managed to improve mine productivity, lowering cash costs per ton by approx $20, and reduced SG&A costs by over $10 million per year.

During this time, Alpha has focused on becoming a pure play met producer, taking drastic measures to shed its thermal coal assets. The stock suffered through a dramatic selloff in mid to late 2019, see below:

I believe the uncertainty around the PRB asset liabilities started the precipitous decline, followed by weaker than expected earnings in early November, which cut the stock in half overnight. CEO David Stetson called it an “irrational depression.” Keep in mind, this selloff occurred prior to COVID.

Despite the lower share price, Alpha made some good moves, committing the limited capital it had available for three new mines:

Black Eagle
Lynn Branch
Road Fork 52

In hindsight, the timing of these mines could not have been better; they were at the absolute bottom of the cycle. Now that the CAPEX associated is mostly in the rear view mirror, and met prices have drastically improved, the FCF numbers to follow from these investments should be quite generous.

Prices & Proforma

Alpha typically exports approx. 65-70% of their met volumes internationally. Their met pricing so far in 2021 has been lackluster due to a material portion of export sales to India. These Indian volumes have to compete directly with the Australian coking coals, which have been discounted somewhat relative to CFR China prices ever since the Chinese ban on Australian coal. Moving forward into the second half of the year, prices have continued to improved drastically for met priced CFR China. This has caused the Australian coking coal prices to trend higher as well, albeit with a wider relative discount compared to before the ban:

I expect Alpha’s export sales in Q3 and Q4 to be $120/ton and $130/ton, respectively. While their domestic sales (~35%) remain locked-in around $88/ton for the remainder of 2021, these sales should jump significantly for 2022 to around $120/ton. I’m going to be conservative and forecast 2022 export sales to come in at $125/ton FOB mine (transportation to DTA of around $20/ton deducted).

Although my price expectations are conservative, the results to Alpha’s bottom line are drastic. Refer to the proforma below:

If you ignore the anomalous year that was 2020, Alpha’s turnaround from 2019 to 2021/2022 is impressive. Remember, 2019 was a fairly healthy coal market for most of the year and Alpha still could not keep their costs down. The strategy of focusing on positive profit margin operations and closing or selling the dead-weight assets should finally begin to payoff in the coming quarters. Once the dead-weight was cut from the portfolio, management began focusing on cost reduction efforts at it’s core operations. The resultant reduction in mining costs should pay off handsomely in the future if they can keep them around $70/ton, which is fairly low on the global cost curve.

Summary

Alpha is a turnaround story and the positive narrative is just starting to come into focus. The valuation for 2022E FCF/EV is 37% or 2.7x. For a met producer with high quality assets, a diversified customer base, and a management team which has demonstrated they can cut costs and focus on managing the productive assets well, it’s definitely cheap despite the recent rally.

Since the inception of this newsletter, Alpha Met and Warrior Met have been the two cheapest met producers I’ve analyzed completely; both coming in around 40% 2022E FCF/EV. Given that Warrior Met probably trades at a discount due to it’s ongoing strike with UMWA, we have to give Alpha the nod as the valuation winner so far.

In hindsight, it’s easy to see why the stock as almost tripled this year. If you believe met prices will remain elevated for the foreseeable future then Alpha should definitely be on your watch list. As of this writing in late September, I’m personally hoping for a pullback so that I can add AMR back to the portfolio in size, and with leverage, in order to play for positive Q3 earnings results as a price catalyst.

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The Coal Trader

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