Arch Coal Inc. (ACI)

Q2 2012 Earnings Call

July 27, 2012 11:00 AM ET

Executives

Jennifer Beatty – VP, IR

John Eaves – President and CEO

Paul Lang – EVP and COO

John Drexler – SVP and CFO

Analysts

Andre Benjamin – Goldman Sachs

Mitesh Thakkar – FBR

Brandon Blossman – Tudor Pickering Holt

Shneur Gershuni – UBS

Brian Gamble – Simmons & Company

Michael Dudas – Sterne Agee

John Bridges – JP Morgan

Kuni Chen – CRT Capital Group

James Rollyson – Raymond James

David Katz – JP Morgan

Brett Levy – Jefferies

Chris Haberlin – Davenport

Brian Yu – Citi

Curt Woodworth – Nomura

David Gagliano – Barclays

Paul Forward – Stifel Nicolaus

Lucas Pipes – Brean, Murray, Carret & Company

Lance Ettus – Tuohy Brothers Investment Bank

Richard Garchitorena – Credit Suisse

David Beard – IBERIA

Justine Fisher – Goldman Sachs

Wayne Atwell – Global Hunter

Presentation

Operator

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Please standby. Good day everyone, and welcome to this Arch Coal Incorporated Second Quarter 2012 Earnings Release Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to Miss Jennifer Beatty, Vice President of Investor Relations. Please go ahead, ma’am.

Jennifer Beatty

Thank you. Good morning from St. Louis. Thanks for joining us today.

Before we begin, let me remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, may be considered forward-looking statements, according to the Private Securities Litigation Reform Act. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the Securities and Exchange Commission, may cause our actual results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

I’d also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which is posted in the Investor section of our website at archcoal.com.

On the call this morning, we have John Eaves, Arch’s President and Chief Executive Officer; Paul Lang, Arch’s Executive Vice President and COO, and John Drexler, our Senior Vice President and CFO. John, Paul and John will begin the call with some formal remarks and then we’ll be happy to take your questions. John?

John Eaves

Thanks, Jennifer. Good morning. Today Arch reported an adjusted net loss of $0.10 per share in the second quarter and generated $181 million in EBITDA. These results reflect the impact of the depressed coal markets as well as our success in adjusting to operations to address these conditions. Our quarterly results exclude one-time noncash charges related to mine closures and good will impairments, which John Drexler will address in his prepared remarks.

It has been a busy and challenging three months for Arch Coal. The year-to-date decline in coal demand has been unprecedented, yet we’ve been successful in executing on a plan to improve our operational efficiency, optimize our asset portfolio and enhance our financial flexibility and we’ve made great strides on each of those areas.

First and foremost, we proactively addressed any near term covenant or refinancing concerns by restructuring our debt to eliminate any maturities until 2016, and relax any restrictive covenants until 2014. We’ve also increased our cash on hand over $500 million and have additional liquidity available under our undrawn revolver to manage through this downturn.

Second, we continue to take aggressive steps to control costs and improve operational efficiencies. And, we’re seeing results with an increase in our second quarter operating margin, despite 11% drop in shipments quarter-over-quarter. Paul Lang will provide in more detail on how we’re controlling our costs and allocating capital in the current market condition.

Third, we’re realigning our Appalachian asset portfolio towards higher met mines. Given the muted outlook for domestic thermal coal in that region, we’ve taken the hard step and idled five higher cost thermal operations that were unable to earn an adequate return in the current market. It was a difficult but necessary decision that was made to enhance our competitive cost structure in Appalachia and to position Arch for long term success.

Beyond those actions, we continue to evaluate non-core assets and reserves for possible divestiture, although I don’t want to set an expectation that a transaction is certain to occur. We know the inherent value of our assets and our reserves, and we don’t plan to give that value away. We’ve taken the right steps to strengthen our balance sheet, allowing us to take a disciplined approach as we review our portfolio. With that said, at this time, we don’t intend to provide any further details on this matter.

Turning now to market dynamics, we believe that we’ve reached an inflection point in the domestic thermal markets. It has felt like spring from January until May, which caused a record build in U.S. coal stockpiles. Those stockpiles most likely peaked at around 205 million tons in May, just above the record set during 2009.

Recently though demand has begun to outpace thermal supply, with stockpiles declining in June. Over the last five years, the average drawdown in stockpiles from May to August has been around 20 million tons, and that includes the last two years where the summer was very hot.

It’s certainly possible if the summer weather holds up to see a drawdown of 30 million tons this year, resulting in stockpiles of 175 million tons by the end of August. While this level is still 20 million tons above normal, it would be a step towards rebalancing the U.S. thermal market.

Another potential catalyst for coal demand is the rise in natural gas prices. Above $3 per million BTU, we think the economics has slung back in the favor of PRB coal. Of course, most units are running reasonably hard right now anyway, so an increase in coal burn was relatively certain, but at prices above $2.75 per million BTU, we think PRB will compete with combined cycle gas plants even after the summer ends. In fact, train traffic is increasing out of the PRB, which is evidence that demand is improving. Arch’s shipments in the PRB for July have been picking up from second quarter levels. In addition deferrals, which were common place in the spring, have diminished. Overall, we believe that customer stockpiles in the PRB-served regions could approach more normal levels by the end of the year.

Another positive market data point is the pace of the U.S. coal exports. They continue to surprise to the upside. We recently raised our total industry forecast to 120 million tons, based on strong trends through June and our forecast does anticipate some weakening in the second half.

At Arch, we have shipped a record 7 million tons for export year-to-date and would expect that we’ll reach our goal of 12 million tons for the full year. While pricing is not where we’d like, we continue to see solid demand for our coals. We are moving PRB coal to Korea and China, Western Bit coal to Europe and the Middle East, and Appalachian coal all over the world.

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