ARCH - Arch Q3 Preliminary Results: Use This Breather To Pick Up A High Dividend

2023-10-17 12:22:32 ET

Summary

• Arch Resources, Inc.'s latest quarterly results show a reduction in coking coal volumes, leading to a downward revision of approximately 9%.
• Despite the near-term problems, Arch's Q3 results point towards a combined capital return of dividends plus buybacks of nearly 10%.
• The stock's clean balance sheet, net cash position, and potential for coking coal volumes to regain strength make it a worthwhile investment.

Investment Thesis

Arch Resources, Inc. (ARCH) is a stock that I have recommended to investors because of its very high dividend.

Since I first recommended the stock, it has delivered strong dividends. However, its latest news see Arch Resources having to reduce its estimates for coking coal volumes.

Readers need to read my previous analysis, where I explain what Arch Resources does and why metcoal is completely different from thermal coal in its end uses.

This is the conclusion from this analysis: Arch's Q3 preliminary results point towards combined capital return of dividends plus buybacks of nearly 10%. And even as I hoped for more, I still believe this is an attractive investment. After all, I don't believe that Arch's near-term problems will last indefinitely.

Q3 Preliminary Results

Back in Q2 2023 , Arch guided for approximately 8.5 million tons of coking coal (metcoal).

However, its preliminary Q3 results now point to around 8.6 to 8.9 million. In the worst-case scenario that's a downward revision of approximately 9%.

At the same time as Arch downwards revised its coking coal volumes by 9%, they stated that cash costs for producing coking coal have increased by slightly over 3%, compared with their prior estimates provided in Q2.

Further, back in Q2 2023, Arch's free cash flow was approximately $150 million. However, Arch guides that this quarter will be approximately $80 million or thereabouts.

This means that Arch will continue to see its balance sheet increase its total cash balance, albeit, in fairness, not by much.

In keeping with Arch's capital allocation policy to return 50% of its free cash flows as a dividend and the other 50% as buybacks, I believe that Arch's dividend this quarter will be around $2 per share.

Here's the math. I've assumed that $40 million of the $80 million of free cash flow is returned as a dividend. This implies approximately $2 per share of dividend. If we assume this figure annualizes (meaning times 4, for each quarter), this means that Arch's dividend yield this quarter ends up as a 5% yield.

That being said, know that Arch is going to return the ''other 50% of its free cash flow'' as buybacks. This will mean that Arch's combined yield from its dividend and buybacks will end up being around 10% total yield for this upcoming quarter.

Again, here's the math. $2 per share for the quarter, equals 5.2% annualized. Although the dividend is not ''annualized'' since it changes down or up every quarter. The other 50% of the return will come via buybacks.

I recognize that Arch has been a very volatile stock in 2023. However, of late, the stock has clearly been moving higher. And if despite the misfire in this quarter's performance, its total combined yield still reaches around 10%, I believe that this stock is a keeper.

What's more, there's no doubt that metcoal stocks have seen their fundamentals improve, as metcoal prices have improved.

As you can see above, metcoal stocks have clearly been outperforming the energy index in the past 3 months. As such, it's only logical that these stocks would take a breather from time to time.

The Bottom Line

Arch Resources, Inc.'s clean balance sheet continues to support the bull case. According to my estimates, Arch's net cash position stands at around $80 million of net cash. Meanwhile, collecting around 10% combined yield plus its capital appreciation makes this a worthwhile stock in our portfolio.

There's undoubtedly uncertainty over when coking coal volumes will once again return to their previously expected strength? Certainly, I believe it's reasonable that the troubles at South Leer won't be permanent and should in time regain their footing.

That being said, Arch Resources, Inc. is clearly making solid free cash flow in this positive coking coal price environment. Altogether, I believe there's a positive risk-reward balance in this stock.

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