Weak Production Still Hurting Arch Coal

NEW YORK ( TheStreet) -- During the past five years investors in coal stocks have felt nothing but misery due to weak prices of coal and natural gas. But Arch Coal ( ACI), second in the U.S. to Peabody Energy ( BTU) in terms of coal production, has taken more than its share of the punishment. The stock has lost more than 90% during that span.

That said, while I do believe Arch Coal stock has seen its worst, I didn't come away thinking that there was true long-term potential in the shares following the company's weak October quarter. In fact, since that earnings report, these shares have been down by as much as 6%, which has caused investors to wonder if Arch Coal is worthy of a "bottom trade." I don't have a problem with that.

Although the business is not as bad is it used to be, customer demand has yet to fully return. There have been some positive signs in the shift from coal to natural gas, but due to weak production, there has been no growth to speak of. And at this point, I have no confidence this industry will ever blaze up. So despite the attractive valuation, we must ask: Where's the growth going to come from?

On Tuesday, management will try to spark things up when the company reports fourth-quarter and full-year results. The Street will be looking for a loss of 37 cents per share on revenue of $769 million, which would represent a 20% year-over-year revenue decline, not to mention a wider loss. And with weak shipments in the Powder River Basin coupled with production struggles in the Mountain Laurel complex in Appalachia, investors won't have much, if anything, to celebrate about.

With these meaningful declines expected in both revenue and earnings, investors can only hope to find some silver lining in operational improvements. It would also be encouraging if management can offer some glowing words about the future of the thermal coal market. The other thing to remember here is that although the company is expected to report a quarterly loss, any sequential progress should not be discounted given Arch Coal's status as a strong dividend payer.

To that end, whatever management can do to strengthen and improve cash flow should be appraised relative to what is posted by Peabody and to a lesser extent Alpha Natural Resources (ANR). What this means is that investors should find solace (I won't say good news) in the fact that Arch Coal is holding its own when compared to Peabody and Cloud Peak Energy (CLD), which are also suffering.

Investors should pay attention to the extent to which Arch Coal management is able to reduce operating cost per ton. Although demand may be weak, there still can be an upside surprise if the company can maintain strong operational efficiency. That's been the only real distinguishing factor in a sector where everyone's struggling. In that regard, Alpha Natural Resources and Peabody stand out.

Along those lines, it's worth noting that Arch Coal management has yet to warm up to the idea that this industry can be re-ignited, despite constant claims from investors describing these companies as "having potential." Arch Coal management isn't buying it. Not unlike Cloud Peak or Alpha Natural Resources, Arch Coal management has fought the pressure to fan the flames of optimism.

For instance, upon releasing third-quarter results in October, Arch Coal's management stated: "So while we are seeing some signs that coal markets are poised to improve, we aren't ready to predict that turnaround will occur." While I never had a problem with this statement, it went directly against the positive outlooks issued by Cloud Peak, Alpha Natural and Peabody.

There may be some truth in what management has said. It's also possible that they are just being overly cautious. But I wouldn't go out of my way trying to read between any lines. This sector, particularly this company, has yet to earn the full benefit of the doubt. With debt still being a burden, I'm going to remain on the sidelines until Arch Coal can get back to posing break-even results.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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