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Arch Coal Remains Underperform

Zacks Equity Research

We reiterate Underperform recommendation for Arch Coal Corporation (ACI) as its lackluster performance in the first quarter of 2012 is attributable to lower domestic sales and increasing operating costs. The company missed both our top- and bottom-line expectations.

Although the demand downturn in the coal markets is expected to reverse in the near and long term, Arch Coal will remain sensitive to certain potential generic risks including recent stress laid by governments on pro-environment measures which could lead to severe cost austerities.

The unexpected rise in price of input supplies and failure to acquire or renegotiate high profile customer contracts could hamper the company’s opportunities for future growth. Exposure to political and economic risks in its overseas operations and failure to supplement its reserves on a continued basis could act as limiting factors.

On the bright side, we expect Arch Coal to benefit from a reversal in the coal market near term, in particular for metallurgical coal exports, riding on the global upsurge in the steel sector. We also view the company’s priority in retaining a flexible financial profile will enhance its asset base. The measure taken like reduction of the dividend rate and securing $1 billion term loan without financial maintenance covenants is appreciable.

The profitability of the coal miners is heavily influenced by its ability to mine and process high quality coal reserves in a cost efficient manner and its ability to find new economically viable reserves. Failure to add economically viable reserves might lead to a vicious cycle of negative profitability as lower financials will restrict further financing of coal operations.

Arch Coal’s earnings guidance in fiscal 2012 includes targeted coal production of 136–142.5 million tons and capital expenditures in the range of $400–$410 million. The Zacks Consensus Estimates for the second quarter and fiscal 2012 are currently pegged at negative 15 cents per share and negative 44 cents per share, respectively.

Arch Coal presently retains a Zacks #4 Rank which translates into a short-term Sell rating. The company’s peers include Penn Virginia Resource Partners LP (PVR) and Alpha Natural Resource Resources Inc. (ANR).

Based in St Louis, Missouri, Arch Coal Corporation engages in the production and sale of steam and metallurgical coal. The company sells steam coal to power plants and industrial facilities, and metallurgical coal for use in steel production worldwide.

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