Publicly traded US coal producers aren't likely to splurge on acquisitions or growth projects in the coming years, and instead should distribute their earnings to shareholders, an equity analyst report said Tuesday.
Seaport Global's Mark Levin said a number of producers, including Peabody Energy, Arch Coal and Contura Energy, have emerged from reorganization with little debt and "are now in excellent position to generate substantial cash flow, particularly in 2017 with met[allurgical] coal prices likely to remain elevated for some time."
Given that acquisitions saddled many coal companies with too much debt the last time met coal prices spiked, Levin said company officials will be leery to make the same mistake twice, and "investors simply don't want it."
In addition, declining thermal coal demand isn't likely to trigger development of any new mines, argued Levin, who said the US thermal coal market is "at best mature and more likely in secular decline."
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He added that new US met mines are also unlikely without the benefit of a long-term contract, particularly given the country's role as a swing producer.
"When demand slackens or low-cost supply comes on elsewhere, the US can feel the brunt of the pain," wrote Levin.
"With that in mind, we think most investors don't want to see companies do anything that grows capex or production."
Levin suggested coal producers adopt a dividend policy similar to Rio Tinto, the London-based mining giant that bases its quarterly dividends on financial results, commodity outlook and the board's view of the long-term growth prospects of the business, all balanced against the objective of maintaining a strong balance sheet.
Levin believes the current shareholder base is largely made up of "hedge funds trading with other hedge funds" and suggested that rethinking returns will attract old investors, many of whom lost confidence in coal given bearish market fundamentals, regulatory risk and corporate mismanagement, "particularly as it related to capital allocation."
"This is a golden chance for boards and managements to get a fresh start with old investors and expand their potential shareholder base," wrote Levin.
Levin said producers should "acknowledge the volatility and fickleness of coal demand," and give back more to investors when prices are high but withhold returns when prices dip.
"Investors will understand, as long as there is a disciplined, well-thought-out approach," wrote Levin.
--Andrew Moore, firstname.lastname@example.org
--Edited by Valarie Jackson, email@example.com