Arch Resources: A Softer Q1 But Reasonably Good Discretionary Cash Flow

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Arch Resources, Inc. is a U.S. coal mining company with a focus on metallurgical coal sales.Both the metallurgical and thermal segments saw lower production and margin compression in Q1 2024....

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Monty Rakusen Overview Arch Resources, Inc. (NYSE:ARCH) is a U.S. based coal mining company, which I have covered frequently over the last year. Those articles can be found here. The company has a large amount of thermal coal production, with most of that in the Powder River Basin. However, the margins are much better for the metallurgical (\"met\") coal sales, which is true in general, but specifically for Arch, which sells most of its thermal coal on the domestic market but most of its met coal on the seaborne market. So, the margin difference is massive, and I consequently view Arch primarily as a met coal producer. Figure 1 - Source: Arch 2023 10KFigure 2 - Source: Arch 10Ks Arch this morning released its Q1 2024 results, which this article will focus on. In late March this year, the Francis Scott Key Bridge in Baltimore collapsed after a container ship struck one of its piers. This impacts Arch, which exports met coal from the Curtis Bay Terminal in Baltimore, but the company is working to redirect coal to the Dominion Terminal in Newport News, Virginia. The company has so far not changed its annual guidance for 2024, and the current expectation is that the disruptions will be isolated to Q2, even if that is, of course, dependent on the main channel in Baltimore reopening later in Q2, which is the latest estimate. Q1 2024 Result Arch reported quarterly revenues of $680M in Q1 2024. The adjusted EBITDA was $103M in Q1 2024, down 43% compared to $180M in Q4 2023. Net income came in at $56M, down 56% compared to the prior quarter. This translated to an EPS in the quarter of $2.98, beating the consensus EPS estimate of $2.93 marginally. Figure 3 - Source: Quarterly Reports The met segment was impacted by a somewhat weaker sales volume in Q1, with 2.2M tons sold compared to 2.3M tons in Q4. The sales price declined to $150/t in Q1, as we have seen met coal benchmark prices decline lately. Costs continue to be very competitive at $94/t, even if they increased quarter-over-quarter. So, there were several factors leading to a compressed margin in Q1, even if $56/t is still a respectable figure. Figure 4 - Source: Quarterly Reports The thermal segment had a weak quarter, with a declining sales volume and effectively no margin. The thermal segment operated at breakeven during Q1, due to a weak domestic thermal market but also because of more stripping than shipping during the quarter, which will benefit the thermal margin in the second half of 2024. However, the weakness in the thermal segment should not come as a surprise, since Arch has guided for minimal EBITDA contribution from the thermal segment in 2024. Figure 5 - Source: Quarterly Reports Operating cash flow in Q1 was $128M and discretionary cash flow or free cash flow was $83M, discretionary cash flow was reasonably good considering this was a softer quarter. Figure 6 - Source: Quarterly Reports Arch is committed to returning 100% of discretionary cash flow to shareholders, which is, of course, a great feature of the company. 25% of the distributions are in the form of dividends, while the remaining 75% will be in the form of buybacks. The next dividend payment in mid-June will be $1.11 per share. The company has also built up some liquidity recently, which can be used for more aggressive buybacks if we see a more pronounced weakness during the year. The diluted share count was at the end of Q1 2024 down to around 18.5M compared to 21.3M shares 2 years ago. Guidance & Valuation The 2024 guidance was provided along with the Q4 2023 results a few months ago, and the company has so far not made any adjustments following the disruptions related to the Francis Scott Key Bridge collapse. However, the guidance might need to be revised if the main channel reopening in Baltimore is delayed. The below chart is based on the latest guidance from Arch using a few different met coal price scenarios for 2024, where the gross profit from the thermal segment is estimated to be around $30M, which is very low in a historical comparison. Figure 7 - Source: My Estimates  Despite the weakness in thermal coal prices and more recently also coking coal prices, a free cash flow yield in the 10-15% range is probably still a realistic assumption for 2024 cash flows. Unless we see more of a recovery towards the second half for met coal prices, we are likely at the lower end of that range. Conclusion Q1 was a relatively soft quarter for Arch Resources, Inc., due to slightly lower production and some margin compression. However, Arch still has a free cash flow yield in the 10-15% range, which is in my view a very attractive cash flow multiple for a company with plenty of metallurgical reserves, a negative net debt, and 100% of discretionary cash flow being distributed to shareholders. So, I consider Arch a great risk reward, and I am long the stock. In prior articles, I highlighted the expected increase in ETF ownership. The percentage owned by ETFs has gone from 22% to 37% in a couple of months, even if that hasn't caused much of a stock price reaction, likely due to having coincided with the weakness in met coal prices. Figure 8 - Source: Koyfin  The increased ETF ownership could still mean the buybacks will have more of an impact going forward, as the free float decreases. With that said, a higher percentage of ETF ownership could potentially make Arch Resources, Inc. stock more susceptible to general market weakness as well.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2430238541"}