Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on Alpha Metallurgical Resources Inc. (NYSE: AMR)
Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled "A High Alpha Short Opportunity" that outlines why we believe shares of Alpha Metallurgical Resources, Inc. (NYSE: AMR) ( "Alpha" or the "Company") face up to 40% to 60% downside risk, or $60.58 ? $90.87 per share. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and important updates.
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Spruce Point Report Overview
Founded in 2016 as Contura Energy, the Company has a close history to the old Alpha Natural Resources (ANR), a levered roll-up of U.S. coal assets that filed for bankruptcy in 2015. Along the way, Contura acquired some of ANR's assets and later merged with ANR, divested its Powder River Basin and Northern Appalachian assets, and changed its name to Alpha Metallurgical Resources to position itself as a high value producer and exporter of metallurgical coal that goes into steel markets.
Despite its best efforts to shed its dark past, we believe Alpha is still a dirty coal company with challenged mining assets, problematic financial reporting and accounting practices, and insiders that put their own interests ahead of shareholders, the environment, and public interests. Key findings from our report on Alpha include:
- Questionable Business Activities and Reporting Between Closely Associated Companies. Many of Contura's executives came from ANR. Spruce Point observes that Alpha made numerous reporting changes to how it classifies freight and handling revenues and costs. At first, it allocated all the costs to the Trading & Logistics segment. Then, it allocated costs among its various regional production segments. Alpha's freight and handling reporting per ton is suspiciously higher than all of its U.S. reporting coal peers. Contura's old Trading & Logistics business was buying a substantial amount of coal from ANR. We find evidence of negative revenue in Q4 2018. We also show that 2017 segment revenues were quietly changed between Contura / ANR from $478 to $566 million. In the intercompany eliminations Alpha shows $566.5 million of purchased coal which is more than the costs for the entire segment which was $543.2 million. Furthermore, the merger proxy shows the intercompany business to have revenues matching costs, yet Contura was claiming the segment produced $89 million of EBITDA.
- Substantial Missing Export Revenue to Brazil. The "export" story is central to Alpha's investment case. Alpha says that Brazil is a critical market with export revenue exceeding 10% of total revenue. Therefore, we estimate that Brazil accounted for a minimum of $226 and $142 million of export revenue (inclusive of freight) in 2021 and 2020, respectively. Spruce Point has sourced Brazil import records amounting to 626k and 866k metric tons shipped in 2020 and 2021. Using published reference prices, we estimate Alpha's revenues from coal sold to Brazil were closer to $95 to $99 million, materially below reported figures.
- Evidence of Inflated Reserves and Concerns of Independence on the Reserve Report. Spruce Point warns investors about putting too much reliance on Alpha's stated reserves. At IPO, it promoted over 1.3 billion of proven and probable reserves. Since then, it acquired 611 million tons from the ANR merger in 2018 and divested approximately 733 million of PRB and NAPP reserves. Production has amounted to approximately 86 million tons from 2016 ? 2021. Yet, after revisions and implementing new SEC reporting guidelines, proven and probable reserves are just 351 million tons. Spruce Point observes that Alpha has used a relatively small firm in Virginia as its "Qualified Expert". The consent form is increasingly being signed by a principal lower down the chain of command. Furthermore, there are subtle language changes being made that raise concerns. Notably, there are hints to suggest that the initial reserve estimates may not have been "independent".
- Evidence of Critical Operating Expense Avoidance Through Dominion Terminal ? An "Affiliate". Alpha's investment case relies heavily on its ability to export coal to foreign markets. It prominently touts its 65% ownership of Dominion Terminal Associates (DTA) which allows it to store, and efficiently facilitate the movement of coal through seabound shipping routes. However, there is evidence that Alpha has booked revenues from customers using DTA, and avoided recognition of DTA's operating expenses. Alpha claims DTA is an equity affiliate, and records non-cash "other expenses" related to DTA that does not affect EBITDA or operating cash flow. DTA is a money losing-asset that requires annual capital contributions, but none of these expenses affect operating metrics. Based on a relative reporting analysis between Alpha (65%) and Arch Resources (35%), it also appears that Alpha may be under-reporting DTA costs.
- Evidence of Overstated Cash, Significant Cash Shortfalls, and Substantial "Hidden" Off-Balance Sheet Debts. A recent analysis of Alpha's interest income shows a precipitous decline in Q3 and Q4 2021. Inclusive and exclusive of restricted cash and investments, we estimate it earned just 6 and 2 basis points, respectively of annualized interest on cash. This could suggest periods where intra and/or inter-quarter, it was short on cash. Underscoring our concern of cash overstatement, we find irreconcilable differences in cash spent on share repurchases and cash raised through warrants being exercised between the Statements of Equity accounts and Statements of Cash Flow. We also observe its "restricted" cash and assets has been increasing. Looking carefully at its "Cash Interest Expense" disclosed at the bottom of the Statements of Cash Flows, we observe that it rose by $13.8 million in 2021 despite lowering its Term-Loan balance through optional debt repayments, and shrinking off-balance sheet liabilities such as Surety Bonds and Letters of Credit. Based on this unexplained $13.8m of cash interest cost, and making some assumptions about the associated interest expense, we estimate $138 - $690 million of "hidden" interest-bearing debt. Alpha's days sales outstanding have been increasing which indicates difficulty collecting cash. We observe that China was briefly listed as a major customer in late 2021. It is possible Alpha sold coal into China to boost sales, but received poor payment terms. We also observe that freight and logistics costs per ton sold increased markedly by 122% from Q2 2021 to Q1 2022. Higher transportation costs generally make Alpha's export coal less attractive to foreign buyers. Lastly, we see a deterioration of earnings quality with net income recently exceeding operating cash flow.
- Core Cash Flow From Mining Masked By Non-Standard Cash Flow Statement Format. We believe Alpha's cash generation shouldn't be taken at face value. To illustrate, 48% of cumulative operating cash flow from 2019 ? 2021 came from tax refunds and interest on NOL carryback claims, most of which were higher than initial guidance provided in 2019. For comparison, during the same period, Arch and Peabody generated 12% and 8% of cash flow from refunds, respectively. These "one-time" refunds won't be repeated, and will become a major headwind going forward. Secondly, Alpha's cash flow statements include discontinued operations, whereas under best practices for financial reporting, it should separate out discontinued cash flows. Recent divestitures include NAPP and PRB operations. By adjusting the cash flow statement to remove these items, and making further adjustments to include the capital cost of operating the DTA export terminal, we estimate that core cash from mining operations is materially overstated. As presented, 2019 ? 2021 cumulative cash from operations is $436 million. However, our pro forma analysis illustrates that cumulative core cash from continuing mining operations was $184 million.
- Follow-The-Money, Insiders Sold Heavily 20% Below the Current Price. Alpha trades at an unjust premium for what we believe are lower quality coal operations and assets. In fact, according to Good Jobs First, an organization which tracks corporate violations, Alpha (and its predecessor ANR) leads the entire U.S. mining industry with a record $564m in fines and penalties mostly tied to safety and environmental compliance. We believe Alpha should trade at a discount to peers to incorporate its poor track record and our concerns around accounting, financial reporting, and financial strains being observed with "hidden" liabilities. We believe investors also underappreciate customer risk in the Alpha story. We believe China, a recent large customer, will dramatically expand imports from Mongolia. India, a 29% customer in Q1'22, has not been growing met coal imports YTD. Coal prices are projected to decline as more supply comes to market and the Ukraine War shortage premium subsidies. We believe management have been aggressive sellers of stock in a non-transparent way. After FY 2021 earnings results in March, and a $150m repurchase program was announced, management sold 56% of its total stock holdings. However, between March 10th and the filing of the Proxy Statement on March 30, 2022, we estimate insiders sold $24 million of stock in the $117 range (20% below the current price) without filing a single timely Form 4 to notify investors. In addition, warrants issued in 2016 were recently exercised by a large holder. We estimate 40% ? 60% downside risk to $60.58 ? $90.87 per share.
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Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point's full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point has a short position in Alpha Metallurgical Resources, Inc and owns derivative securities that stand to net benefit if its share price falls. Spruce Point has long positions in Arch Resources, Peabody Energy Corp, and CONSOL Energy Inc. and stands to benefit if their share prices increase.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities. Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
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