ARCH - Arch Streaming Cash Dividends Amid Coking Coal Shortfall

Summary

• Arch's 2023 contracted business suggests cash windfall for shareholders.
• $2.8 billion market cap delivered $1.2 billion operating cash flow.
• Metallurgical premium coal margins expanded 400% amid tight supply.
• 2023 dividend outlook tracking similar to $24/share paid in 2022.

Arch Resources' (ARCH) dynamic capital return performance is bound for a repeat performance in 2023. Management decision to carefully manage balance sheet by avoiding acquisitions and dilutive capital outlays resulted in huge cash windfalls returned to shareholders including $25 dividends.

Benefitting from a position of supreme strength, Arch is a low cost producer of premium high vol-A coking coal where it holds an approximate 30% market share. Margins have exploded 400% since 2017 as met coal prices rose sharply.

A look at past 6 years of company performance shows consistent price gains (*2020 Exception) versus modest cost increases with 2022 reflecting new supply expenditures.

Arch Resources Met coal price vs cash costs

(Compiled from Arch public reports)

2022 premium coal sales price advanced 77% doubling the 37% cash cost increase. Company has released 2023 cash cost guidance at $84 per ton (2/16/23 Conference call) which would be a 12% decrease.

India/Asia driving demand for coking coal

US Coal exports to India and Asia are growing rapidly as developing economies require this critical steel making resource. Company estimates that 58 million additional tons of coking coal will be required over the next 4 years while supply constraints persist due to lackluster industry capital investment. Arch forecasts increased production of met coal from 7 million tons/annual to 9 million in 2023.

2023 Business outlook

Arch is monetizing thermal coal orders in advance contracts for future years through 2026. I find the company strategy of locking in profitable orders rather than attempting to wait for prospectively higher prices quite compelling. The volatility in coal prices can swing in both directions and precise timing is impossible. $273 million in likely thermal coal 2023 profits has been achieved based on company guidance showing 68.2 million tons of coal contracted (company 10K - 2/16/23). The math is based on company guidance at ~$4/ton thermal margins. Most advance contracts are at fixed prices with step up pricing in multi year deals, and some price trigger escalations depending on market conditions at time of product transfer.

Competitors such as Alpha Metallurgical (AMR) have seen their stock prices rally amid increased demand and constrained supply. Alpha recently announced an impressive $220 million fourth-quarter profit, despite challenging short term mine impacts. Mining poses geologic risks that impact quarterly results and Arch is weathering similar challenges. US railroad companies are experiencing labor shortages leading to reduced shipping capacity which has hurt coal producers nationally. While this issue constrains production, it also serves to ratchet prices even higher.

Arch stock is underpriced by the market at $158 per share with 2022 earnings per share at $63.88 indicating a 2.5 P/E ratio. The balance sheet is very strong with long term debt at $116 million and cash at $236 million. Capital expenditures to support production at these levels was only $176 million on the year, while delivering $1.3 billion in operating cash. Management is aggressively repurchasing shares, having eliminated approximately 1 million last year, and likely to repeat this general trend in 2023. I am focused on a 15% return via dividend, a 5% return via projected reduction in share count, and a $200 target price in 2023. Investors must be willing to overlook short term coal price swings and focus on superior cash flows over the next several years.

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