Arch Coal, Inc. ( ACI) Q3 2011 Earnings Conference Call October 28, 2011 11:00 AM ET Executives Deck Slone – VP, Government, Investor and Public Affairs Steve Leer – Chairman and CEO John Eaves – President and COO John Drexler – SVP and CFO Analysts Brian Gamble – Simmons & Company Shneur Gershuni – UBS Paul Forward – Stifel Nicolaus Mitesh Thakkar – FBR Capital Markets Michael Dudas - Sterne, Agee & Leach Holly Stewart – Howard Weil Mark Levin – BB&T Capital Markets Andre Benjamin – Goldman Sachs Group Lucas Pipes – Brean Murray, Carret & Co. Brian Yu – Citigroup, Inc Brandon Blossman – Tudor, Pickering, Holt & Co. Meredith Bandy – BMO Capital Markets Richard Garchetorina – Credit Suisse First Boston Lance Ettus – Tuohy Brothers Brett Levy – Jefferies & Company David Katz – JP Morgan Justine Fisher – Goldman Sachs Presentation Operator Good day, everyone, and welcome to the Arch Coal Incorporated Third Quarter 2011 Earnings Release Conference Call. Today’s call is being recorded.
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 we have posted in the Investors section of our website at archcoal.com.On the call this morning, we have Steve Leer, Arch’s Chairman and Chief Executive Officer; John Eaves, Arch’s President and Chief Operating Officer; and John Drexler, our Senior VP and CFO. Steve, John and John will begin the call with some brief formal remarks, and thereafter we’ll be happy to take your questions. Steve? Steve Leer Thank you, Deck, and good morning. In the third quarter of 2011, Arch reported adjusted earnings per share of $0.08 and record $211 million in EBITDA. Quarterly revenues reached $1.2 billion and EBITDA grew year-over-year even with lower PRB shipment and a longwall outage in Appalachia. Year-to-date we have also generated record free cash flow, a combination of incremental earnings and prudent capital spending. While our quarterly performance and revised full-year earnings guidance are below our second quarter expectations and projections, we remain on track to deliver the best year yet for Arch. In particular and as previously announced, our third quarter performance reflects lower PRB shipments on rail disruptions due to flooding, as you know, our second quarter shipments in that region were affected, and this issue continued into September, impacting plant volumes. However, we’re seeing a recovery in October and expect to end the year with a strong fourth quarter performance at our PRB operations. In addition, we experienced difficult geology and a longwall outage at Mountain Laurel during the third quarter that reduced our sales of met coal and raised our quarterly cost in the region. To remind everyone, Mountain Laurel re-entered the final panel of the Alma seam in August. This is the same panel that costs us an outage in the first quarter. The final panel are two of any coal seam often represents the most challenging job geology of a coal mine, and this is proving to be the case at Mountain Laurel. As such, we produced our met coal volume expectation for the full year largely due to lower high-vol B sales out of Mount Laurel.
At the same time, we expect Mountain Laurel to transition our SS time. We expect Mountain Laurel to transition to the Cedar Grove theme in mid-first quarter of 2012. We also believe that the Cedar Grove seam will have a stronger met properties in the Alma seam and the mining conditions in the Cedar Grove will be significantly better than what we’ve encountered during 2011. Our Cedar Grove is a moderately thinner seam than the Alma seam.Overall, Mountain Laurel has been a star performer for Arch since it opened in the fourth quarter of 2007 and we expect it to continue to be a major contributor to the company’s future profitabilities throughout the current decade and beyond. More importantly, Arch have significantly expanded our met mine profile in Appalachia, while diversifying our sources of supply, with the addition of the high-quality ICG met coal assets. By mid-2013, Arch will have an even more powerful portfolio of met coal operations in Appalachia, anchored by low cost longwall mines at Tygart Valley and Mountain Laurel and exceptional continuous miner operations at Beckley and Sentinel. These four cornerstone operations will be further supported by met production from Vindex, Cumberland River, Buckhannon and Lone Mountain. We are also moving forward aggressively with planning work on a second longwall mine at the Tygart Valley number two high-vol A reserve now called Shelby Run with the goal of starting up that operation towards the end of our five-year time horizon. We are also strong believers not only in the continued demand for met coal in the developing world, but also in the scarcity of high-quality met coal supply. While there will be an inevitable volatility, we believe increased demand and constrained supply will be the prevailing factors in the met coal markets over the next five years, and we’re preparing to capitalize on that trend.
Turning to current state of the global met coal markets, we continue to see a very constructive environment. In fact, domestic steel utilization has averaged at above 75% since July. Remember that utilization dipped below 40% at the depths of the recession of 2009. On a global scale, year-to-date steel production has increased 8% through September and capacity utilization has risen to 79%.That being said, steel production in China slowed in September due to consolidation efforts and some slowdown in end-user demand. But the month-over-month reduction in Chinese steel output was offset by a rebound in European steel sector, even with some announced mill idling there. So we are cautiously optimistic about the near-term and believe met coal markets will remain relatively tight. Although we expect some easing from the record price level set earlier this year, our guidance also reflects and assumed a modest weakening in demand for lower quality met coal, driven by the economic uncertainty in Europe. The outlook for global thermal markets remains positive despite the overhang of the European debt crisis and the recent decline in ARA prices. We anticipate growing coal demand in Western and Eastern Europe in 2012, a function of higher natural gases, German nuclear plant shutdowns, destocking, and reduced supply availability from traditional sources. In fact, while over 78% of South African exports have been diverted from the Atlantic to the Asian-Pacific to date, we anticipate that Asia could capture 90% or more of South African output over the next five years. Coal demand in Asia remained strong, helped by the return of Japan to the market place, a pickup of other Southeast Asian nations, and continued growth in China. According to industry estimates, met coal imports into the Chinese mainland will reach at least 150 million metric tons in 2011. Furthermore, despite the talk of Indian price sensitivity, we still believe that the country will import 30% more coal than it did in 2010, and we haven’t even mentioned Central and South America, and, specifically, Brazil, where a doubling of coal import is expected by 2015. Read the rest of this transcript for free on seekingalpha.com