ARCH - Alpha Metallurgical Resources: Metcoal A Crucial Element For Modernization

2023-09-18 14:16:48 ET

Summary

• Metcoal is essential for steel production, supporting critical industries like construction, automotive manufacturing, and data center warehousing.
• Alpha Metallurgical Resources, Inc. offers significant potential, driven by strong free cash flows, but investor preferences may vary based on balance sheet considerations.
• Alpha's decision to cease its dividend program in favor of share buybacks reflects market valuation dynamics, raising future questions about its capital allocation.

Investment Thesis

Alpha Metallurgical Resources, Inc. ( AMR ) predominantly produces metallurgical coal, the linchpin of steel production, as metcoal transitions into coke, the indispensable fuel in blast furnaces.

Steel is a crucial material in construction, automotive manufacturing, and data center warehousing buildings. Indeed, President Biden's three bills, infrastructure building (''IIJA''), inflation reduction (''IRA), and CHIPS act, all provide stimulus to the steel industry.

The main consideration to think about here is that AMR, together with Arch Resources ( ARCH ) and Warrior Met Coal ( HCC ), are all being priced in the bargain basement. (Note, I'm long ARCH).

There may be some minor nuances that distinguish these companies, but for all intents and purposes, they are all betrothed to the same investment thesis, in that they've all been left for dead while throwing off very strong free cash flows.

Why Invest in Metallurgical Coal?

The modernization of our economies hinges on the availability of metallurgical coal (metcoal). From constructing computing data centers to manufacturing offshore wind turbines, all these critical endeavors rely on steel, a fundamental building block of modern infrastructure. Metcoal's role in steel production is indispensable, ensuring the strength, durability, and cost-effectiveness of vital components for our advancing world. Without metcoal, the foundation of progress in industries across the board would be compromised, underscoring its pivotal role in driving economic growth and innovation.

Why Invest in Alpha Metallurgical Resources?

As I've alluded to already, metcoal stocks are to a large extent based on the same thesis. In my opinion, the main distinguishing feature, will boil down to their respective balance sheets, indeed more so than their cost structure. Why?

While I recognize that in the very long-term, a coal company's cost structure will carry greater significance than its balance sheet, at the same time, we have to keep in mind that the market is discounting these coal company's cash flows so aggressively, that investors are not pricing in more than 3 years out, if that.

Case in point, AMR will probably end up making more than $750 million of free cash flow in 2023, and the stock is priced at less than 5x this year's free cash flow.

What Are the Drawbacks?

This aspect depends on the investors' temperament. Personally, I'm not a fan of management teams that switch their capital allocation depending on how the wind blows.

Case in point, AMR decided that going forward it will no longer have a dividend on the stock, here's the quote from the earnings call ,

The dividend program will cease following the Board's next dividend declaration and payout, both of which are expected to occur in the fourth quarter.

On the other hand, for their part, AMR defended their decision when asked about its change in capital allocation by saying this in the Q&A section of the call,

[This decision to stop the dividend buyback is] strictly has to do with how the market values our company. If we believe the valuation is appropriate, then we might consider going that direction. But it seems like we're pretty long ways away from that.

[...] So I think we're very content to get to this pure share buyback program and stay there until the market determines it's going to appropriately value us, and then we'll consider some adaptation to the program.

As I've noted already, perhaps I'm biased since I'm long ARCH and that company remains resolute on its 50%/50% dividend to share repurchase policy. However, let's ponder on this, will AMR continue to deploy its buyback while its shares are running up, and reward sellers of their stock at the expense of long-term holders?

Again, this is all down to investors' preference.

The Bottom Line

Alpha Metallurgical Resources, along with other metallurgical coal producers, plays a pivotal role in supporting the modernization of our economies.

AMR, Arch Resources, and Warrior Met Coal are currently trading at bargain prices, presenting a compelling investment opportunity. While there may be minor distinctions among these companies, they share a common investment thesis of strong free cash flows and stable futures.

However, investors should consider factors like balance sheets and management decisions, such as AMR's decision to cease dividend payouts, when evaluating these opportunities.

The metcoal industry's significance in driving economic growth and innovation cannot be understated, making it a compelling investment choice.

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