Arch Resources: back with a potentially massive 20%+ return (NYSE: ARCH)

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Introduction

It seemed like most investors had viewed coal as a dying relic after the last decade, especially with the focus on transitioning to clean energy, albeit in the wake of the current global energy shortage that has sent price spike, it now appears that coal’s early demise was overstated. This sent income from Arch Resources (NYSE:ARCH) to levels that were probably never considered possible and saw them declare a record dividend. If this continues, it should see the king of coal return with a potentially massive 20%+ dividend yield in 2022, but looking further into the future, investors would be wise to remain cautious.

Executive summary and ratings

Since many readers are likely short on time, the table below provides a very brief summary and scores for the main criteria assessed. This Google document provides a list of all my equivalent ratings as well as more information about my rating system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.

Arch Resource Ratings

Author

*Instead of simply assessing dividend coverage through earnings per share cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their financial situation.

Detailed analysis

Arch Resources cash flow

Author

After suffering a very painful downturn in 2020 due to the Covid-19 pandemic which saw their operating cash flow demolished to $61.1 million from $419.7 million in 2019, thankfully 2021 has represented a relatively solid recovery with their result landing at $238.3 million. Although this is nothing compared to 2022, which in the first quarter has already recorded operating cash flow of $292.9 million and has so far exceeded its entire result in 2021, although that it represents only one quarter. As this came with relatively very low capital expenditure, the majority translated into free cash flow and therefore see prospects for a massive dividend yield of over 20% given their new yield policy for shareholders, consistent with management’s comments included below.

“In February 2022, Arch announced a new capital allocation model that includes returning to shareholders 50% of prior quarter discretionary cash flow – defined as operating cash flow less 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% of discretionary cash flow from the prior quarter for use in share buybacks, repurchase of potentially dilutive securities, special dividends and/or preservation of capital.”

-Arch Resources Announcement of first quarter 2022 results.

This new shareholder return policy resulted in a special dividend of $7.86 per share for the first quarter of 2022, which increased their usual quarterly dividend by $0.25 per share, which together amount at 4.90% of their current price of $165.72 and therefore on an annualized basis. , represents a very high yield of 19.60%. It remains to be seen how they have allocated the additional 50% of their free cash flow in the second half of 2022 now that they have reached a net cash position, as discussed later, although it is not unrealistic to see this result in their dividend. efficiency reaching well over 20%. While this sounds very exciting, investors would be wise not to lose sight of the medium to long term because despite their website posing as a metallurgical coal company, realistically in 2021 the vast majority of their volumes of sales were actually thermal coal, as shown in the table below.

Arch Resources Coal Volumes

Arch Resources 2021 10-K

It can be seen that 2021 saw sales volumes of 72.7 tons, of which 65.2 tons were attributable to thermal coal, thus representing a share of around 90%. While thermal coal miners have enjoyed booming operating conditions throughout 2022 with a spike in prices following the Russian-Ukrainian war that saw Europe ban imports of Russian coal, the market will eventually rebalance in the years to come. When that inevitably happens, thermal coal will always be the last choice in this era of clean energy and so its price is virtually certain to come back lower, the only unanswered question is whether that will happen in 2022 or 2023 or may be later.

Given this outlook, investors would be wise to consider the downside risk and not get carried away with the excitement of their massive dividend yield of over 20% in the near term. While the inherent volatility of coal prices makes estimates difficult, it appears that their free cash flow of $137.6 million in 2019 should provide a suitable interim basis, as the year was neither particularly strong nor weak. Even if they returned all of this to their shareholders in the form of dividends, it would only provide a moderate return of around 5.30% on current cost given their current market capitalization of around $2.6 billion. . While that’s not necessarily terrible, I doubt it’s enough to sustain their stock price around its current highs or provide some nice earnings considering the long-term threats they face as the world turns the corner. back to thermal coal in the medium and long term.

Capital structure of Arch Resources

Author

After years of putting their balance sheet ahead of shareholder returns, investors can now sit back and enjoy the benefits with their cash balance of $318.7 million actually exceeding their debt balance of 314, $9 million, leaving a very desirable net cash position. This means that it would be pointless to assess their leverage in detail since they are not leveraged and going forward their variable shareholder return policy should see this continue, their cash outflows being matched to their cash inflows.

Arch Resources Liquidity Ratios

Author

When a company has a relatively very large cash balance, it effectively becomes apparent that its liquidity will be strong, as it did in this situation with its current ratio of 1.78 and its cash ratio of 0.63 , indicating that it does not face any other crippling non-debt liabilities on the horizon. In addition to seeing no leverage, their net cash position also means that they face no risk from any upcoming debt maturities since they obviously have the cash to meet their obligations and then again given their variable shareholder return policy, this dynamic should not change in the future.

Conclusion

While the early demise of Royal Coal has been overstated, these booming mining conditions giving rise to a massive dividend yield of 20%+ if these coal prices continue, realistically it is unlikely that ‘they last for the long haul, especially given the secular decline that thermal coal demand is facing in the transition to clean energy. This means that their free cash flow and therefore their dividends will almost certainly go back down in the future and given that downside risk I only think a neutral rating is appropriate because if their free cash flow goes back to its level in 2019, their shares would only trade with a moderate yield of around 5%.

Notes: Unless otherwise stated, all figures in this article are taken from Arch Resources’ SEC Filingsall calculated figures were performed by the author.

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