Drew Industries, Inc. (DW), Arch Coal Inc (ACI): Wednesday’s Top Upgrades (and Downgrades)

You’re recommending coal? Really?
Today, we’ve saved the strangest analyst recommendation for last. In a world where the only thing plunging faster than clean natural gas prices is utilities’ desire to buy dirty coal, one analyst has taken it upon itself to recommend buying Arch Coal Inc (NYSE:ACI).

This morning, FBR Capital bravely announced that it is resuming coverage of Arch Coal Inc (NYSE:ACI) with an “outperform” rating and a $6 per share price target. According to FBR, Arch Coal Inc (NYSE:ACI)’s sale of its Canyon Fuel subsidiary to Bowie Resources for $423 million in “net proceeds” has given Arch Coal Inc (NYSE:ACI) the cash it needs to wait out the downturn in coal demand, and survived until an “improvement in coal markets” materializes.

As FBR crunches the numbers, Arch Coal Inc (NYSE:ACI) currently has a “pro forma cash balance of $1.3 billion (including marketable securities).” With much of its debt having been pushed back in maturity, FBR sees no serious threat to Arch’s liquidity in the short term, and believes the company will survive quite well until “coal markets stabilize and ACI resumes free cash flow generation.”

Of course, that comment only highlights the fact that Arch Coal currently does not generate free cash flow . To the contrary, Arch burned through $73 million in negative free cash flow over the past 12 months, while racking up a $392 million GAAP net loss.

Even taking FBR’s estimate of $1.3 billion in “pro forma cash” at face value, with more than $5.1 billion in debt to its name, and no free cash flow with which to pay down that debt, Arch remains in exceedingly dire financial straits. If a revival in coal demand does not emerge as quickly as FBR expects, or never emerges at all, the company may not survive.

Weighing the prospect of a 27% profit if FBR is right about its price target — but the potential for a 100% loss if it’s wrong — I’m inclined to think that discretion is the better part of value here. I’d advise against buying Arch shares.

The article Wednesday’s Top Upgrades (and Downgrades) originally appeared on Fool.com is written by Rich Smith.

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