Found this Reddit post on ARCH, a coal company that is more heavily focused on the “coking” side than power plant fuel. Post below:
Did you know that cigarette companies are one of the all-time great investments? Since 1985, Altria (MO) has returned about 18%/year, far outpacing the market. Sin stocks pay big rewards because some people refuse to buy them. This drives down the PE, which means that profits are compounded at much higher rates. A stock with a PE of 4 can return 25% per year even with zero growth.
So what’s the ultimate sin stock in the year 2022?
Arch Resources (ARCH) is a company that mines metallurgical coal (used in steel production) and to a lesser extent thermal coal (used in power plants). They have several mines throughout the United States - sitting on around 800,000 acres of land.
Q1 2022 was a transformative quarter for ARCH. They earned $17.60/share and announced a dividend of $8.11/share. If they maintain this performance for the entire year, they will have a PE of 2.3 and a yield of 20%.
But analysts expect more. So far, the price of coal in Q2 has been higher than in Q1. Analysts expect earnings to increase and remain elevated for the remainder of 2022.
#In all, the company will earn half of its current market cap in 2022 alone.
Arch has used its windfall profits to clean its balance sheet. Net debt has been reduced to zero. Nearly all earnings from now one will to be distributed to shareholders.
This is where things get spicy. Arch wants to return most of its cash flow to investors, half in the form of dividends and half in the form of buybacks. They are not buying new coal mines. Here I’ll quote directly from the earnings call.
In February 2022, Arch announced a new capital allocation model that includes the return to stockholders of 50 percent of the prior quarter’s discretionary cash flow – defined as cash flow from operations minus capital expenditures and contributions to the thermal mine reclamation fund – via a variable quarterly cash dividend in conjunction with a fixed quarterly cash dividend.
Arch intends to retain the remaining 50 percent of the prior quarter’s discretionary cash flow for use in share buybacks, the repurchase of potentially dilutive securities, special dividends, and/or capital preservation.
Note that, in Q1, discretionary cash flow was almost the same as earnings. All in all, I would expect the vast majority of future earnings to be returned as dividends or as a buyback. This could amount to as much as $80 in capital return per share in the next year, equal to 50% of the share price.
Why is it so cheap?
This one is easy. Go to the mall and tell a hot girl that you are investing in coal. Watch her facial expression. Coal companies are cheap because coal is a dirty, no good, sinful thing.
Isn’t coal going away?
Not before companies like Arch return huge multiples of their current value in dividends to savvy investors. Also, most of Arch’s coal profits come from “coking” or “metallurgical” coal, used in blast furnaces. I don’t think is going away as quickly as thermal coal, used in power plants.
Weirdly, 25% of the float of ARCH is sold short. I’m honestly not sure what to make of this but thought it’s worth mentioning. The stock is up 84% YTD so these shorts must have extremely high pain tolerance.
Some people have claimed the short position is some sort of hedging for convertible notes. This is not accurate. As of May 19, Arch has only $30 million of convertible notes outstanding, less than 1% of market cap.
Future price of coal
(from the 10-Q)
China’s ban on importation of Australian coal remains in place, and we believe the supply of previously impounded Australian coal that was released during the fourth quarter of 2021 has been effectively exhausted. North American coking coal supply remains constrained compared to pre-COVID-19 levels, despite historically high indices. Some new supplies have been added to the market, in particular, our new Leer South longwall operation. Still, some of the high cost coking coal mine idlings announced during 2020 remain in place, and production and logistical disruptions also constrain supply. The duration of specific supply disruptions is unknown. We believe that underinvestment in the sector in recent years underlies the current market situation. In the current environment, we expect coking coal prices to remain volatile. Longer term, we believe continued limited global capital investment in new coking coal production capacity, normal reserve depletion, and continuing economic growth will provide support to coking coal markets.
Domestic thermal coal consumption was supported by continued high natural gas prices during the first quarter of 2022. Our thermal segment shipment volume increased significantly year-over-year, but was constrained by rail service capacity. Longer term, we continue to believe thermal coal demand will remain pressured by continuing increases in subsidized renewable generation sources, particularly wind and solar, and planned retirements of coal fueled generating facilities. Currently, however; the sustained increase in natural gas prices has led to a significant economic advantage for coal fired electricity generation. We believe coal generator stockpiles are likely below desired levels at many power stations. In the wake of the Russian invasion of Ukraine, international thermal coal market indices increased to historical highs. While we are effectively completely committed for 2022 Thermal Segment sales at currently planned production levels, we do have some export volume that remains open to pricing based on these indices.
Not expanding, praise be!
(From the 10Q)
Longer term, we will maintain our focus on aligning our thermal production rates with the secular decline in domestic thermal coal demand, while adjusting our thermal operating plans to minimize future cash requirements and maintain flexibility to react to future short-term market fluctuations.
ARCH ranks #3 out of 4403 stocks on SeekingAlpha’s Quant Score.