Coal Earnings ($BTU $ARCH $AMR $HCC $X)

[Previously: Coal Producer Earnings for Q1 2023, Warrior Met Coal, Peabody Energy.]

Peabody Energy
The market capitalization of Peabody (BTU) is now $3.2 billion versus $2.8 billion when we wrote about them last quarter. (It was $4 billion when we wrote about them in August 2022.) Total liabilities less current assets are now $340 million, and current assets now exceed current liabilities plus long term debt. We would put the enterprise value at $3.5 billion now. For the second quarter of 2023 (release), adjusted EBITDA was $358 million, down from $391 million in the first quarter. That puts the EV/EBITDA at 2.4x (annualized).  

During the second quarter, Peabody's seaborne thermal coal sold for $101 per ton with a $51 cost per ton; seaborne met coal for $190 per ton with a $138 cost per ton; PRB coal for $14 per ton with a $12 cost per ton; and other U.S. thermal coal for $54 per ton with a $40 cost per ton. Once again, seaborne thermal coal was the most profitable segment in Q1, earning $198 million of adjusted EBITDA (production was up 10%), with seaborne met right behind, earning $103 million in adjusted EBITDA. The U.S. thermal coal (PRB & other) earned $78 million for the quarter.

Peabody reported "Available Free Cash Flow" (AFCF) for the quarter of $375 million. They have said that they plan to return to shareholders at least 65% of AFCF. That would imply a shareholder yield on the current market capitalization of 31% (annualized). During the quarter, they repurchased $173 million of shares and paid $11 million in dividends. They bought back 8.3% of outstanding shares during the second quarter.

The seaborne thermal coal is mined in Australia. Seaborne met coal is mined in Australia and Alabama. The PRB coal is, of course, mined in Wyoming, and the other U.S. thermal is mined in Illinois, Indiana, Colorado, and New Mexico.

At the end of 2022, Peabody had 2.1 billion tons of proven coal reserves and 379 million tons of probable reserves. The proved reserves were comprised of 94 million tons of seaborne thermal coal, 102 million tons of seaborne met coal, 1.7 billion tons of thermal coal in the Powder River Basin, and 155 million tons of other U.S. thermal coal. The enterprise value is thus $1.62 per ton of proved and probable reserves. One thing to mention is that you get a lot of thermal coal with Peabody: almost 2 billion tons. That is a lot of BTUs and you never know; they might come in handy.

Arch Resources
The market capitalization of Arch Resources (ARCH) is $2.5 billion versus $2.1 billion last quarter. Their total liabilities less current assets are now $143 million, and current assets exceed current liabilities plus long term debt. We would put the enterprise value at $2.6 billion now. For the second quarter of 2023 (release), adjusted EBITDA was $130 million, down from $277 million in the first quarter. That puts the EV/EBITDA at 5x using this quarter or 3.2x using the first half of the year (annualized).

They sold 2.5 million tons of coal in Q2, up from 2.2 million in Q1, but the price of met coal was $153/t versus $210/t the prior quarter. The cash cost per ton was up to $90 versus $83 the prior quarter even though total production was up.

They said they had "discretionary cash flow" of $151 million for the quarter, which was the difference between their CFO of $197 million and $46 million of capital expenditures. They returned all of the DCF to shareholders via a dividend of $75 million and $74 million spent repurchasing stock. That gives a shareholder yield of 24% (annualized) on the current market capitalization.

Alpha Metallurgical Resources
The market capitalization of Alpha Metallurgical Resources (AMR) is $2.6 billion, up from $2 billion last quarter. Their total liabilities (excluding deferred taxes) less current assets are now negative $320 million. We would put the enterprise value at $2.3 billion now. For the second quarter of 2023 (release), adjusted EBITDA was $259 million, down from $354 million in the first quarter. That puts the EV/EBITDA at 2.2x using this quarter or 1.9x using the first half of the year (annualized).

They sold 4.3 million tons in Q2, up from 3.9 million in Q1. They got $173/t for met coal versus $209/t the previous quarter. Their cost of coal sales improved to $106 per ton from $110.56 per ton.

Cash from operations was $317 million and capital expenditures were $55 million. They paid $7 million of dividends and bought back $150 million of stock during the quarter, for a shareholder yield of 24% (annualized) on the current market capitalization. The company announced that they are going to cease paying a dividend after the fourth quarter and focus their cash on share repurchases. (See investor presentation.)

Warrior Met Coal
The market capitalization of Warrior Met Coal (HCC) is $2.1 billion, up slightly from $2 billion when we wrote about them last quarter. Their total liabilities (excluding deferred income taxes) less current assets are negative $700 million, so the enterprise value is $1.37 billion. For the second quarter of 2023 (release), adjusted EBITDA was $130 million, down from $259 million in the first quarter. That puts the EV/EBITDA at 2.6x using this quarter or 1.8x using the first half of the year (annualized).

They sold 1.8 million tons versus 1.9 million in the first quarter, although the production level was actually higher this quarter. The average price fell from $257/t to $209/t and the cash cost increased from $119/t to $129/t. 

Cash from operations was $125 million and they spent $136 million on capital expenditures. Warrior is developing a Blue Creek mine, and this capex is displacing shareholder returns. What's worse is that there have been some cost overruns:

More than a year after the relaunch of the Blue Creek mine development in May 2022, Warrior has initiated important and highly beneficial project scope changes that will require incremental capital expenditures over the life of the project while lowering operating costs, increasing flexibility to manage risks, and make better use of multi-channel transportation methods. Most of these scope changes are transportation and logistics-related, with additional amounts related to inflation for these changes only. They are expected to increase total capital expenditures for the Blue Creek mine by approximately $120 - $130 million over the remainder of the project development period. [...]

In addition, the Company has experienced inflationary cost increases ranging from 25 to 35 percent in both operating expenses and capital expenditures for its existing mining operations since late 2021. The Company is also experiencing inflationary pressures at Blue Creek, especially in relation to labor, construction materials and certain equipment, that is expected to continue during the remainder of the project development period. As a number of key material contracts are currently being negotiated, and due to uncertainty regarding future inflation rates, the Company is not providing an estimate of the impact of inflation at this time. [...]

Subject to the considerations discussed above, our revised estimate of capital expenditures in 2023 for the development of the Blue Creek mine is approximately $250 to $300 million and is subject to change. The increase in 2023 capital expenditure estimate is primarily driven by change in transportation scope discussed above. The Company currently expects development spending at Blue Creek to be the highest in 2023 and 2024, with 2024 being a similar amount to 2023 that is subject to change.

The project remains on schedule with the first development tons from continuous miner units expected in the third quarter of 2024 and the longwall scheduled to start up in the second quarter of 2026.

It is not clear whether it is a great idea to be expanding capacity when the met coal price is already showing some weakness. Why not just return cash to shareholders? Maybe it's a smart investment, if the coal price holds up for the next decade, but the market is already saying (through the producers' valuations) that it doesn't believe that the coal price will hold up for even a couple years.

United States Steel Corporation
The market capitalization of U.S. Steel (X) is $5.5 billion, up from $4.9 billion when we wrote about them last quarter. Their total liabilities (excluding deferred income taxes) less current assets are $1.1 billion, so we would put the enterprise value at $6 billion.  For the second quarter of 2023 (release), adjusted EBITDA was $804 million, up significantly from $427 million in the first quarter. That puts the EV/EBITDA at 1.9x using this quarter or 2.4x using the first half of the year (annualized). Some color on developments:

“We are executing exceptionally well against our strategic initiatives, with all in-flight projects progressing on-time and on-budget. Notably, our non-grain oriented, or NGO, electrical steel line at Big River Steel is currently being commissioned and on track to start-up later in the third quarter. Customer demand has been robust for our NGO steels and we are pleased to announce that we've already secured our first customer orders in both industrial and electric vehicle markets.”

For the current year-to-date, the company has generated cash from operations of $894 million but spent $1.4 billion (157% of cash from operations) on capital expenditures. They have borrowed $200 million, repurchased $150 million of stock, and drawn down cash by $420 million. For the period of 2021 through the first half of 2023, U.S. Steel generated $8.5 billion of cash from operations. They invested $4.6 billion of that in capital expenditures.

As we mentioned last quarter, it does not seem great to spend more than 100% of cash from operations on capital expenditures when your company is valued at ~2x EBITDA and your market capitalization is half of book value. Those are strong signals from the market not to be investing in capacity. 

There is enormous volatility in product demand and price for U.S. Steel's products. Over the past four quarters, the price of flat rolled steel has been as low as $1,012 per ton and as high as $1,339 per ton. The price of steel pipe has been as low as $2,727 per ton and has high as $3,757 per ton.

We just saw today that offshore driller Valaris is borrowing money to buy more ships. When you invest in cyclical industrial companies a constant theme is valuations that are (ostensibly) punishingly cheap but where managements want to expand capacity. If the demand was so great you could theoretically lay the risk off on the customers with long term contracts for the output - but you never see this. (Although the WSJ points out today that small bakeries have figured out that capping croissant production is good for profits.)

We keep coming back to the question of producers versus royalties. The conventional wisdom being, "date the producers, marry the royalties." In theory, there is a set of relative valuations at which you should be indifferent between the two business models. And if the royalty companies are selling for 2% free cash flow yields but the producers are 1x EBITDA, you should probably prefer the producers.

Where this gets more difficult is when the royalty companies are also cheap (say, double digit yields) and the producers are expanding production instead of returning cash. If we look ahead a year or two, what if that cheap producer ends up expanding, having cost overruns on its expansion, and it and its competitors end up reducing their margins because of the increased capacity? The amount of cash that shareholders ultimately receive may be a lot less than the EBITDA multiple suggests. That would imply that the producers are never as cheap as they look.