Coal Earnings Notes (Q1 2024)

Metallurgical coal prices have been a bit soft so far this year. Since coal miners have operating leverage as well as capital expenditure requirements, you would expect that their free cash flows have suffered more than the royalty owners' have. And as we pointed out in January, the royalty owners  - which hold the senior securities in the capital structure of mines - seemed cheaper than the producers.

It is a concern that the miners are expanding met coal production even while the commodity price has been weak and their own shares have been "cheap". Warrior's new Blue Creek mine is expected to produce 5 million tons per year and Peabody's North Goonyella / Centurion mine is supposed to produce 3 million tons per year. To put that in perspective, 8 million tons of new capacity is about equal to what Warrior produces in total now.

It seems like a possible "base case" is that the miners' predictable over-investment in capacity will result in the commodity price trending towards marginal cost. The miners will be able to earn a profit margin during times of strong steel demand, but we are not really seeing anything that would show us that mining has become a good business or that the executives recognize that they are not in a good business.

People are working on electrolysis of iron ore (which would be like aluminum production) as well as hydrogen based reduction for steelmaking. Either of those innovations would disrupt metallurgical coal and what they would mainly require is cheaper electricity. It does not seem prudent to invest capital in new coal mines without establishing long term sales contracts with financially sound entities to sell the output. The miners could idle the expansion projects and have the option to start them at such time that they could guarantee an attractive market for the output.

We follow four coal producers and three royalty owners. The miners are Alpha Met (AMR), Warrior Met (HCC), Arch Resources (ARCH), and Peabody (BTU). The mineral owners are Natural Resource Partners (NRP), Pardee Resources (PDER), and Beaver Coal (BVERS). Some notes on the results:

Alpha Met
The market capitalization of AMR is now $3.7 billion (at $285 per share), down quite a bit from $5.75 billion at the high in February. Results for March 31st (10-Q) show Alpha's current assets less total liabilities (ignoring deferred taxes) were $248 million (about the same as year-end 2023) which puts the enterprise value at $3.45 billion now.

For the first quarter of 2024, AMR's adjusted EBITDA was $190 million (down from $266 million the prior quarter) which puts the EV/EBITDA at 4.5x. AMR sold 4.4 million tons of met coal in Q1, down from 4.6 million in Q4. They got $167/t for met coal versus $184/t the prior quarter, and the cost per ton was down slightly to $116/t versus $119/t.

Cash from operations was $196 million and capital expenditures were $72 million for the quarter (including $8.5 million of contributions to equity affiliates), for $124 million of free cash flow, an annualized yield on the enterprise value of 14%. They paid $3 million of dividends for the quarter and bought back $116 million of stock, for a shareholder yield of 13% (annualized) on the current market capitalization. The share count was down 14.8% year-over-year.

Warrior Met
The market capitalization of HCC is now $3.3 billion (at $63.25 per share), down about 10% from a recent all time high of $70 in late April. Results for March 31st (10-Q) show Warrior's current assets less total liabilities (ignoring deferred taxes) were $422 million which puts the enterprise value at $2.89 billion now.

For the first quarter of 2024, Warrior's adjusted EBITDA was $200 million (up from $164 million the prior quarter) which puts the EV/EBITDA at 3.6x. Warrior sold 2.1 million tons of met coal in Q1, up from 1.9 million tons in Q4. They got $234/t for met coal versus $258/t the prior quarter, and the cost per ton was down slightly to $133/t versus $147/t.

Cash from operations was $104 million and capital expenditures were $102 million for the quarter. There was an adverse change in working capital (mostly paying down trade accounts receivable) that negatively affected cash from operations by $87 million. If you add that back, free cash flow would have been $89 million, which is a 12% yield on the enterprise value.

The company paid $31 million of dividends and did not buy back any stock, making the shareholder yield 3.8% (annualized). It seems like it would be a good idea not to be expanding production, as we have previously observed.

Arch Resources
The market capitalization of ARCH is now $2.8 billion (at $156 per share), down about 15% from the all time high in March. Results for March 31st (10-Q) show Arch's current assets less total liabilities (ignoring deferred taxes) at negative $104 million which puts the enterprise value at $2.9 billion now.

For the first quarter of 2024, Arch's adjusted EBITDA was $103 million (down from $180 million the prior quarter) which puts the EV/EBITDA at 7x. Arch sold 2.2 million tons of coal in Q1 (both met and thermal coal), down from 2.3 million tons in Q4. They got $166/t for met coal versus $196/t the prior quarter, and the cost per ton (both met and thermal combined) was up to $94/t from $87/t. Note that the cash margin per ton was thus down one-third just from the prior quarter.

Cash from operations was $128 million and capital expenditures were $45 million for the quarter, resulting in $83 million of free cash flow, an 11% yield on the enterprise value. The company paid $44 million of dividends and bought back $14 million of stock, making the shareholder yield 8.3% (annualized).

Peabody
The market capitalization of BTU is now $2.8 billion (at $22.50 per share). Results for March 31st (10-Q) show Peabody's current assets less total liabilities (ignoring deferred taxes) at negative $263 million which puts the enterprise value at $3.1 billion now.

For the first quarter of 2024, Peabody's adjusted EBITDA was $161 million (down from $345 million the prior quarter) which puts the EV/EBITDA at 4.8x. Peabody's seaborne thermal earned $94 million of EBITDA for the quarter, the seaborne met earned $48 million, Powder River Basin earned $16 million, and other U.S. thermal earned $46.5 million.

Cash from operations was $120 million and capital expenditures were $68 million for the quarter, resulting in $52 million of free cash flow, a 6.7% yield on the enterprise value. The company paid $10 million of dividends and bought back $83 million of stock, which resulted in a 3% share count reduction.

Natural Resource Partners
The market capitalization of NRP is now $1.16 billion (at $90 per unit) and as of March 31st (10-Q) the partnership has $175 million of long term debt and $72 million of convertible preferred stock, for net liabilities of $220 million. The enterprise value is thus $1.39 billion.

NRP generated $72 million of free cash flow in the first quarter of 2024 and $312 million of free cash flow over the trailing twelve months. The first quarter figure, which annualizes to $288 million, is a 20.7% yield on the enterprise value.

After the end of the first quarter, NRP settled the remainder of its warrants and bought back more than half of its convertible preferred units. Our best guess now is that the partnership has an enterprise value of $1.35 million. Assuming an annualized free cash flow of $280 million, that would still be a yield of greater than 20% on the enterprise value. Also, it would mean that estimated remaining net liabilities of $175 million could be paid off in about 2.5 quarters, which would mean the end of this year. The stated intention of management is to begin distributing cash to shareholders once all liabilities are paid off. That would indicate a possible annual distribution of $20, which would be a 22% yield on the current unit price, assuming that current level of free cash flow holds.

Pardee Resources
Pardee is interesting because it owns a huge amount of land in West Virginia, both the surface with timber and also the mineral rights. The current market capitalization (at $250 per share) is $166 million and the company reported $35 million of current assets net of all liabilities at March 31, which gives an enterprise value of $131 million. That is $845 per acre, which seems quite low compared to what timberlands are worth, not to mention the mineral rights and other assets.

Pardee earned $5 million of EBITDA in the first quarter, which was down 17% y/y. The coal royalty per ton was down (because of lower commodity prices received by their lessees), but the lessees' production levels were up. That gives a yield of 15.5% on the enterprise value (annualized).

Beaver Coal
Beaver Coal is a partnership that also owns land in West Virginia (only about one-third as many total acres as Pardee) and unlike Pardee is also getting ground lease income from real estate tenants, in addition to coal royalties and timber sales. At $2,750 per unit, the market capitalization of the Beaver partnership is $68.4 million. Subtracting the $6.6 million of net current assets, the enterprise value is $61.8 million. 

Beaver's coal royalties were $8.9 million in 2023 vs $9.6 million in 2022. Total revenue was $12.9 million vs $14.4 million. Expenses were $2.3 million vs $2.1 million. Operating income was $10.5 million vs $12.1 million. The enterprise value is $1,246 per acre and the OCF yield on the EV (ignoring working capital changes) is 17%. Shares are trading for under 7x net income.

The partnership has had a cash build from $5.2 million (YE 2022) to $6.1 million (YE 2023), which is an increase of $34 per unit. There has been a net current asset build from $5.1 million to $6.6 million, now standing at $266 per unit of current assets net of all liabilities (excluding deferred revenue).

They had $889k of proceeds from sale of property and equipment (also had $511k expenditure for purchase of property and equipment). The financial statements do not say what the sale or purchases were. This will perhaps be explained in the shareholder letter when they mail the annual report.

Earnings Notes (Q4 2023)

Freeport-McMoRan Inc. (FCX)
For Q4 2023, Freeport reported operating cash flow of $1.32 billion and capital expenditures of $1.36 billion, giving a free cash flow for the quarter of negative $42 million. Their quarterly copper production of 1.1 billion pounds was up 2% y/y, at an average realized price of $3.81 per pound. Their guidance for 2024 free cash flow is $1.2 billion (at $3.75 copper), which would be only a 2% yield on the current enterprise value of $57 billion.

FCX’s consolidated operating cash flows are estimated to approximate $5.8 billion (including $0.1 billion of working capital and other sources) for the year 2024, based on current sales volume and cost estimates, and assuming average prices of $3.75 per pound of copper, $2,000 per ounce of gold and $19.00 per pound of molybdenum. The impact of price changes on operating cash flows for the year 2024 would approximate $400 million for each $0.10 per pound change in the average price of copper, $180 million for each $100 per ounce change in the average price of gold and $120 million for each $2 per pound change in the average price of molybdenum.

Capital expenditures are expected to approximate $4.6 billion for the year 2024 (including $2.3 billion for major mining projects and $1.0 billion for the Indonesia smelter projects). Projected capital expenditures for major mining projects include $1.1 billion for planned projects primarily associated with underground mine development in the Grasberg minerals district and potential expansion projects in North America, and $1.2 billion for discretionary growth projects.

FCX’s financial policy is aligned with its strategic objectives of maintaining a strong balance sheet, providing cash returns to shareholders and advancing opportunities for future growth. The policy includes a base dividend and a performance-based payout framework, whereby up to 50% of available cash flows generated after planned capital spending and distributions to noncontrolling interests would be allocated to shareholder returns and the balance to debt reduction and investments in value enhancing growth projects, subject to FCX maintaining its net debt at a level not to exceed the net debt target of $3.0 billion to $4.0 billion (excluding net project debt for the Indonesia smelter projects).

They are quite leveraged to the copper price as you can see: $400 million additional operating cash flow for each ten cent increment in copper price. Yet even $4.75 copper would only give an additional $4 billion of operating cash flow which would be kind of lackluster on the $58 billion EV. They are crazy to be spending money on growth! They should demand contracts in hand for $6/lb before they spend a penny more on capex.

Barrick Gold Corp (GOLD)
For Q4 2023, Barrick reported cash from operations of $1 billion and capital expenditures of $861 million, giving a free cash flow for the quarter of only $136 million on an enterprise value of $25 billion. Gold production was up 1% y/y in Q4. Their cash cost was $982 per oz and their "all-in sustaining cost" was $1,364/oz. 

Like other commodity producers and miners, they are plowing it into capex: They produced 4.05 million ounces of gold in 2023, down from 4.1 million in 2022 and closer to 5 million in 2020. Cash cost has risen from $700/oz in 2020 to $960/oz last year. Operating cash flow for 2020-2023 (four years) totaled $17 billion but they spent $11 billion on capex. So only $6 billion of cumulative free cash flow ($1.5 billion per year) and production is in decline!

Remember that to recover an ounce of gold they have to process 28 tons of ore, and for every ton of ore, they have to also move 6 tons of waste.

Comstock Resources Inc (CRK)
Comstock produces almost 100% natural gas and sells it for the pittance of $2.50/mcf. They reported negative free cash flow for Q4 and FY 2023 yet they grew production 6% y/y. Although they may get some religion about lighting cash on fire now that natural gas is even lower:

"In response to weak natural gas prices, Comstock plans to suspend its quarterly dividend until natural gas prices improve. In addition, the Company plans to reduce the number of operating drilling rigs it is running from seven to five. Two of the five drilling rigs will continue to be deployed in the Company's Western Haynesville play. As a result, Comstock plans to spend approximately $750 million to $850 million in 2024 on its development and exploration projects to drill 46 (35.9 net) operated horizontal wells and to turn 44 (38.2 net) operated wells to sales in 2024. Comstock expects to spend $125 million to $150 million on its Western Haynesville midstream system, which will be funded by its midstream partnership."

Comstock has $3.4 billion of net liabilities and a $2 billion market cap. It is conceivable that the equity here goes to zero.

PrairieSky Royalty Ltd. (PREKF)
PSK reported revenue for 2023 of $380 million, generated $283 million of funds from operations (74% margin). They spend 13% of revenue on income tax, 9% on G&A expense, 3.4% on finance expense (interest), and about 1% each on production taxes and on exploration and evaluation. The $283 million of funds from operations is a 7% shareholder yield on the $4 billion market capitalization. (Based on Q4 would be an 8% yield.)

Horizon Kinetics wrote about PSK in the annual letter for their Inflation Beneficiaries (INFL) ETF:

"With today’s temporarily depressed energy prices, PrairieSky should be able to generate C$1.50 in FFO/share, which equates to a 7.5% yield. This could be viewed as a “base case” minimum return—assuming no improvement in energy prices, production volumes, or Canadian price differentials. Assuming modest improvement here, namely with pricing and volumes, it is reasonable to expect more than C$2.00/share of FFO, or a 10% yield. If prices rebound more fully, and volume grows even moderately, FFO could exceed C$2.50 share, nearly a 12% yield."

One big hope for PSK would be more export of natural gas from Canada. Their share of natural gas production for the quarter was 5.4 million Mcf of gas which was sold for only $2.19 per Mcf.

Intercontinental Exchange Inc. (ICE)
For the full-year 2023, ICE earned $3.05 billion of free cash flow on $8 billion of total revenue (less transaction-based expenses) for a royalty-like 38% free cash flow margin. The current market capitalization is $78 billion the enterprise value is around $100 billion, so at a 3% free cash flow yield, it is not cheap. Something else to note was FCF was flat from 2022 to 2023. Their M&A goals: "deepen moats, gain intellectual property, increase customer wallet-share".

Peabody Energy Corp (BTU)
The market capitalization of Peabody is now $3.35 billion versus $3.3 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 $335 million, so we would put the enterprise value at $3.7 billion now. For the fourth quarter of 2023, Peabody's adjusted EBITDA was $345 million, up from $270 million in the third quarter. Adjusted EBITDA for the full year 2023 was $1.4 billion which is about equal to the Q4 annualized figure. That puts the EV/EBITDA at 2.7x. Operating cash flow for the quarter was $282 million and $1,036 million for the year. Capital expenditures were $158 million for the quarter and $348 million for the year. So the free cash flow yield on enterprise value is 13% based on the most recent quarter or 19% for the full year.

Thoughts from Coal Trader: "If executed successfully, the Centurion and Shoal Creek organic investments should deliver extremely high IRR's and return significant free cash flow to Peabody in the coming years. Peabody’s team also found a way to further enhance the Centurion investment by acquiring the adjacent Wards Well deposit. These investments will pivot the company more towards the met market where the long term fundamentals are far more favorable compared to thermal. The long term prospects of the company have significantly improved with Centurion being the flagship of their portfolio in the years ahead. The average realizations of the met segment will improve significantly with the addition of Shoal Creek and eventually Centurion. This is probably something that will be overlooked by many analysts, but I believe the 'relativities' in the metallurgical coal market are something the sector if going to have to contend with for far longer than most believe. That is to say, the price spreads between high-quality coking coals relative to lower-quality coking coals may be here to stay..."

Seems cheap and everything, but would rather own coal royalties at current valuations.

Natural Resource Partners, L.P. (NRP)
No year-end results yet, but NRP put out an 8-K in January about a warrant settlement:

On January 29, 2024 (the "exercise date"), holders of Natural Resource Partners L.P.'s (the "Partnership's") warrants to purchase common units ("warrants") exercised 462,165 warrants with a strike price of $34.00. On January 31, 2024, the Partnership settled the warrants on a net basis with $10 million in cash and 198,767 common units. The 15-day VWAP ending on the business day prior to the exercise date was $97.62. Of the originally issued 4.0 million warrants, 1.08 million warrants with an exercise price of $34.00 remain outstanding.

As of the September 30, 2023 quarterly results, NRP had 2,190,000 warrants outstanding. An October purchase (8-K) brought them down to 1.54 million warrants. We had been wondering what they did with their Q4 cash - we won't know for sure for another few weeks until they report earnings, although they did aggressively tackle the warrants. Wonder if they were redeeming the preferred (12% liability) during the fourth quarter?

Exxon Mobil Corp (XOM)
XOM reported cash from operations of $13.7 billion and free cash flow of $8 billion (58% of CFO) for the fourth quarter of 2023. The market capitalization is $400 billion and the enterprise value is $420 billion so the free cash flow yield is 7.6% at current oil (and LNG) price. For the full year of 2023, shareholder distributions were $32.4 billion ($14.9 billion of dividends, and $17.4 billion of share repurchases) which is a 8% shareholder yield.

Imperial Oil Ltd (IMO)
We mentioned IMO last week. Production in the fourth quarter was up 8.5% versus the prior year, while capex for the quarter was down 34% versus the prior year. (See results. Full year capex was down 2% from 2022.) Free cash flow for the quarter was $667 million, which is about an 8.6% yield on the enterprise value. Imperial is a share cannibal. During 2023, they shrank the share count by 8.3%. 

Enbridge Inc (ENB)
Enbridge shares have been really weak, under-performing Enterprise Products, for example. (Also compare with EPD, NTG, and FEI over the past three years.) It's a $70 billion market capitalization company yielding 7.9% (dividend) which is quite high compared to what it has yielded historically. And it is a C-corp so you don't even get the annoying Schedule K-1 that you do from other midstream companies. From the Q4 call:

2023 showcased the predictability of our business amid continued geopolitical instability, persistent inflation and rising interest rates. This is as a result of the 98% of Enbridge's earnings being generated from either cost of service or take-or-pay contract assets. Our debt portfolio is less than 10% exposed to floating rate volatility. Our customer base is over 95% investment grade, and 80% of our EBITDA is earned from assets with protection against inflation. We are rated BBB+ by all rating agencies and remain committed to our long-held leverage target of 4.5x to 5x.

Half of the EBITDA is from their liquids pipelines. They've got the Mainline pipeline from the western Canada oil sands and then the Line 5 that takes it to eastern Canada refiners. The Flanagan South and Seaway can also take that Mainline oil from Canada down to Gulf Coast refiners. ("We transport about 30% of the crude oil produced in North America. We transport about 65% of U.S.-bound Canadian exports.")

A quarter of their EBITDA is gas transmission. They carry from western Canada to export, also to eastern U.S. Connects PA gas to eastern U.S. as well as Gulf Coast. ("Enbridge moves about 20% of the natural gas consumed in the United States. We are the largest natural gas supplier to New England, the Southeast and virtually all of Florida. Our transmission network is also webbed throughout the Gulf Coast. We are also one of the largest offshore natural gas transporters in the Gulf of Mexico.") They are working on LNG export from western Canada, called the Woodfibre LNG project.

Other quarter is gas distribution (utility). ("Enbridge’s gas utility business, Enbridge Gas Inc., becomes the largest by volume in North America—with about 7,000 employees delivering 9.3 billion cubic feet of natural gas per day (Bcf/d) to about 7 million customers.")

Allison Transmission Holdings Inc (ALSN)
We keep noticing ALSN on the daily all-time highs list. Per their website, Allison is the world’s largest manufacturer of fully automatic transmissions and hybrid propulsion systems for commercial-duty vehicles. 

On fourth quarter sales of $775 million, they did $170 million of net income and $186 million of adjusted free cash flow (24% free cash flow margin). On full year sales of $3 billion, they did $659 million of adjusted free cash flow (22% FCF margin). Revenue for the year was up 10% for 2022 and adjusted free cash flow was up 37%. They repurchasing $260 million of shares during 2023 (6 percent of outstanding). The market capitalization is $6.25 billion and the enterprise value is $8 billion, so the FCF yield is 8%.

Penske Automotive Group, Inc. (PAG)
Highlight from fourth quarter results:

For the three months ended December 31, 2023, total new and used units delivered increased 8% to nearly 117,400, and total retail automotive revenue increased 5% to $6.2 billion. Same-store new and used units delivered increased 9% to nearly 116,700, and same-store revenue increased 4%, including a 7% increase in service and parts revenue. Total retail automotive gross profit decreased 1% to $1.0 billion, including a 1% decrease on a same-store basis. Same-store service and parts gross profit increased 7%.

Revenue for the fourth quarter was $7.3 billion, gross profit was $1.2 billion, EBITDA was $357 million, and capital expenditures were $103 million. The current market capitalization is $10 billion. Net income was $190 million for the quarter and $1 billion for the full year.

AutoNation Inc (AN)
Highlight from fourth quarter results:

New Vehicle Gross Profit - Decreased $102 million reflecting gross profit per vehicle retailed of $3,653, compared to $5,633 a year ago, partially offset by an 8% increase in unit sales. Used Vehicle Gross Profit - Decreased $27 million reflecting gross profit per vehicle retailed of $1,455, compared to $1,847 a year ago and a 4% decrease in unit sales. After-Sales Gross Profit - $540 million, an increase of $61 million or 13% from a year ago.

Revenue for the fourth quarter was $6.8 billion, gross profit was $1.2 billion, and net income was $216 million. During the quarter, AutoNation repurchased 1.15 million shares of common stock (3% of shares outstanding at start of quarter) for an aggregate purchase price of $151 million. The current market capitalization is $6 billion. Net income was $1 billion for the full year.

Enterprise Products Partners LP (EPD)
Highlights from fourth quarter results:

Enterprise reported net income attributable to common unitholders of $5.5 billion, or $2.52 per common unit on a fully diluted basis, for 2023 compared to $5.5 billion, or $2.50 per common unit on a fully diluted basis, for 2022. Operational DCF was $7.5 billion for 2023 compared to $7.6 billion for 2022. DCF provided 1.7 times coverage of the distributions declared with respect to 2023. Enterprise retained $3.2 billion of DCF in 2023 to reinvest in the partnership, repurchase partnership common units, and reduce debt. Distributions declared with regard to 2023 increased 5.3 percent compared to those declared for 2022 and marked Enterprise’s 25^th consecutive year of distribution growth.

Steady as she goes. The real question will be, do the growth investments pay off? If so, earnings will rise and capex will go down, resulting in a lot more cash for distributions. (As we pointed out in October, the free cash flow per unit of Enterprise has grown substantially (3.3x) over the past five years.)

Altria, Inc (MO)
Highlight from fourth quarter results:

Smokeable products segment reported domestic cigarette shipment volume decreased 7.6%, primarily driven by the industry’s decline rate (impacted by macroeconomic pressures on ATC disposable income and the growth of illicit e-vapor products) and retail share losses, partially offset by trade inventory movements. When adjusted for trade inventory movements, smokeable products segment domestic cigarette shipment volume decreased by an estimated 9%.

Cigarettes volumes down 9%. Cigarette revenues down 2.4% y/y net of excise tax. They are not able to raise price of pack enough to maintain flat revenue. Operating income from cigarettes down 1.3% y/y.

Chipotle (CMG)
Highlights from fourth quarter results:

Total revenue increased 15.4% to $2.5 billion. Comparable restaurant sales increased 8.4%. Operating margin was 14.4%, an increase from 13.6%. Restaurant level operating margin was 25.4%, an increase of 140 basis points.

Market capitalization is $70 billion, they earned $282 million in Q4 on sales of $2.5 billion. Sixty times earnings is steep! Net income for fourth quarter was up 11% year-over-year.

Marathon Petroleum (MPC)
This Marathon is the refiner, not the E&P company (MRO). They refine almost 3 million barrels per day, which is the most in the U.S., followed by Valero (VLO) and ExxonMobil, each with about 2 million barrels per day. Highlight from fourth quarter results:

“In 2023, the business generated $14.1 billion of net cash from operations, driven by strong operational performance and commercial execution,” said Chief Executive Officer Michael J. Hennigan. “This enabled the return of $12.8 billion of capital to shareholders. We believe MPC is positioned to generate strong through-cycle cash flow with the ability to deliver superior returns to our shareholders.”

That's on a market capitalization of $63 billion. 

Marriott International, Inc. (MAR)
We wrote about Marriott in November as a royalty-like business. Highlights from Q4 results:

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) totaled $1,197 million in the 2023 fourth quarter, a 10 percent increase compared to fourth quarter 2022 adjusted EBITDA of $1,090 million. The company repurchased 4.7 million shares of common stock in the 2023 fourth quarter for $965 million. For full year 2023, Marriott repurchased 21.5 million shares for $3.9 billion. 

In 2024, we expect another year of solid growth and significant shareholder returns. With normalizing RevPAR growth around the world, we anticipate a worldwide full year RevPAR increase of 3 to 5 percent and net rooms growth of 5.5 to 6 percent. We expect this should yield adjusted EBITDA of approximately $4.9 billion to $5.0 billion for the year and enable us to return $4.1 billion to $4.3 billion to shareholders after factoring in $500 million to purchase the Sheraton Grand Chicago.

That would be quite a nice shareholder return on the current market capitalization of $69 billion.

Warrior Met Coal Inc. (HCC)
The market capitalization of Warrior is now $3.2 billion. Their current assets net of all liabilities (ignoring deferred income taxes) are $660 million, so the enterprise value is $2.5 billion. For the fourth quarter of 2023 (release), Warrior's adjusted EBITDA was $164 million, up from $148 million the prior year. For the full year (2023), adjusted EBITDA was $700 million, down from $1 billion in 2022. That puts the EV/EBITDA at 3.8x using the fourth quarter (annualized) or 3.6x using the entire year.

They sold 1.53 million tons versus 1.45 million the prior year. The average price was $234/t and the average cash cost was $121/t. Cash from operations was $245 million for the quarter and they spent $182 million on capital expenditures. 

For the full year 2023, $700 million of cash from operations, but they spent $525 million on capex. No share repurchases, even though the stock was trading for 1.2x EBITDA earlier last year.

The price per ton of met coal averaged $219 in 2023 vs $304 in 2022. It seems insane to invest so much (~$1 billion for the new Blue Creek mine) in producing more of a commodity that does not have a firm price. There are some good pictures of it in the new investor presentation though.

Coal Trader tweeted: "It seems like they’re really struggling to move this coal. Maybe the transition to more HVA is hurting more than I figured, or maybe the spreads in the Atlantic basin are making it more difficult than I assumed. Prices in Q4 were terrible, and inventories increased A LOT."

That's so brutal. There really shouldn't be any question of being able to move the product if you are expanding production.

Occidental Petroleum Corporation (OXY)
From Q4 results, Occidental's oil volume (total U.S.) was down 2.2% in the fourth quarter (year/year). Their total U.S. production in BOEs though was up 1.3%. In the Permian specifically, oil was flat and natural gas was up 14%. The wells are getting gassier!

Total oil and gas capex in the second half of the year was up 4.5% versus the second half of 2022, but in the Permian was actually down 20%. (They really slashed Permian capex in Q4... in Q3 it was up 8% y/y so maybe we'll see volumes fall off more in Q1 2024.)

Their operating cash flow in Q4 was $2.5 billion with capex of $1.4 billion, giving free cash flow of only $1.1 billion. Market cap is $50 billion and the enterprise value is $80 billion. So EV/FCF is only 5.5%.

Truly no idea what Buffett sees here. 

 

Royal Gold Inc. (RGLD)
Reported results: cash from operations was $101 million for Q4 2023 and $416 million for the full year 2023, virtually the same as Q4 2022 and the FY 2022. There were no capital expenditures in Q4 and only $2.7 million for the full year. They spent $325 million on debt repayment and $100 million on dividends. So the shareholder yield is 5.8% on the $7 billion market capitalization. (Net debt is down to $151 million.)

Kraft Heinz Company (KHC)
Noticing from Q4 results that Kraft's North American volumes were down 5.5% despite 2.5% price increase, resulting in fourth quarter sales down 3%. (They're calling this "headwinds that were driven by ongoing consumer pressure".)

 

The market capitalization is $42 billion and the enterprise value $63 billion. Cash from operations for the full year was $4 billion; surprisingly they actually have $1 billion of capital expenditures, so free cash flow is only $3 billion. They spent $191 million on debt repayment, $2 billion on dividends, and $455 million on share repurchases.

Coal & Steel Producer Earnings - Q3 2023 ($BTU $ARCH $AMR $HCC $X)

[Previously: Coal Earnings (Q2 2023), Coal Producer Earnings for Q1 2023, Warrior Met Coal, Peabody Energy.]

Peabody Energy
The market capitalization of Peabody (BTU, 10-Q) is now $3.3 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 $276 million, and current assets exceed current liabilities plus long term debt by almost a billion dollars.

We would put the enterprise value at $3.6 billion now. For the third quarter of 2023, adjusted EBITDA was $270 million, down from $358 million in the second quarter. That puts the EV/EBITDA at 3.3x using this quarter or 2.7x based on the first nine months of this year.

During the third quarter, Peabody's seaborne thermal coal sold for $71 per ton with a $44 cost per ton; seaborne met coal for $160 per ton with a $110 cost per ton; PRB coal for $14 per ton with an $11 cost per ton; and other U.S. thermal coal for $54 per ton with a $42 cost per ton. Once again, seaborne thermal coal was the most profitable segment in Q3, earning $116 million of adjusted EBITDA, with seaborne met right behind, earning $79 million in adjusted EBITDA. The U.S. thermal coal (PRB & other) together earned $103 million of EBITDA for the quarter.

Peabody's "Available Free Cash Flow" (AFCF) for the first nine months of the year has been $648 million. From the start of 2023 through October 20, 2023, the Company has returned $307.4 million to shareholders, including a fixed dividend of $20.7 million and share repurchases of $286.7 million. The Company has repurchased 13.4 million shares, or 9.3% of shares outstanding.

Notice that the EBITDA/EV yield of Peabody is now pretty similar to Natural Resource Partners, but practically all of NRP's EBITDA is free cash flow and is available for distribution to shareholders, while Peabody has spent about $200 million on capital expenditures so far this year. Also, as a royalty owner, NRP's cost of production is zero, while Peabody's operating costs and expenses are two-thirds of total revenue.

Arch Resources
The market capitalization of Arch Resources (ARCH, 10-Q) is $2.8 billion versus $2.5 billion last quarter. Their total liabilities less current assets are now $164 million, and current assets exceed current liabilities plus long term debt by several hundred million dollars. We would put the enterprise value at $3 billion now. 

For the third quarter of 2023, adjusted EBITDA was $126 million, down from $130 million in the second quarter. That puts the EV/EBITDA at 6x using this quarter's results.

They sold 2.3 million tons of met coal (versus 2.5 million the prior quarter) and 16.8 million tons of thermal coal (versus 16.3 million) this quarter. The price of met coal was slightly higher but the net effect with the lower production quantities was that EBITDA was down slightly.

Arch reported "discretionary cash flow" of $87 million for the quarter, which was the difference between their cash from operations of $131 million and $44 million of capital expenditures. They returned $100 million to shareholders via a dividend of $72 million and $28 million spent repurchasing stock.

AMR
Alpha Metallurgical Resources (AMR) is the largest U.S. met coal producer, representing about one-fifth of total U.S. production. According to their recent investor presentation, between two-thirds and three-quarter's of AMR's met coal is exported, with India accounting for a third of their export sales over the past five years.

The market capitalization of AMR is $3 billion, up from $2.6 billion last quarter. AMR stock has really been on a tear since they are allocating lots of cash to share repurchases. Their current assets less total liabilities (ignoring deferred taxes) are now $289 million, so we would put the enterprise value at $2.7 billion.

For the third quarter of 2023 (release, 10-Q), AMR's adjusted EBITDA was $154 million, down from $259 million in the second quarter. That puts the EV/EBITDA at 4.4x using this quarter or 2.6x based on the first nine months of this year.

They sold 4.1 million tons of met coal in Q3, the same as in Q2. They got $155/t for met coal versus $173/t the previous quarter. Their cost of met coal sales was up slightly to $110 per ton from $106 per ton the prior quarter.

AMR has said that they are going to cease paying a dividend after the fourth quarter and focus their cash on share repurchases:

Following the dividend payment for this quarter, we will consolidate our capital return efforts to focus on share repurchases and expect to continue with that approach as long as buybacks make sense from a market, trading price, and valuation perspective.

Cash from operations was $157 million and capital expenditures were $55 million for the quarter. They paid $7 million of dividends and bought back $102 million of stock during the quarter, for a shareholder yield of 14.5% (annualized) on the current market capitalization.

Warrior
The market capitalization of Warrior Met Coal (HCC) is $2.6 billion, up 24% from when we wrote about them last quarter. Their net current assets (ignoring deferred income taxes) are $705 million, so the enterprise value is $1.88 billion.

For the third quarter of 2023 (release, 10-Q), Warrior's adjusted EBITDA was $146 million, up from $130 million in the second quarter. That puts the EV/EBITDA at 3.2x using this quarter or 2.6x using the last nine months' results (annualized).

They sold 2.3 million tons versus 1.8 million in the second quarter. The average price fell from $208/t to $185/t but the cash cost declined from $129/t to $114/t. Cash from operations was $139 million and they spent $112 million on capital expenditures. Very little free cash flow or shareholder returns right now because they are spending it on their Blue Creek project [pdf].

It is a mystery why they are expanding capacity when the met coal price is already showing. Why not just return cash to shareholders? They could also invest in Natural Resource Partners units! In fact, it is kind of comical to be spending money expanding production instead of buying NRP or their own stock.

Maybe Blue Creek will turn out to be a smart investment, if the coal price holds up for the next decade, but the market is already saying (through the royalty owners' and producers' valuations) that it does not believe that the met coal price will hold up for even a couple years.

U.S. Steel
The market capitalization of U.S. Steel (X) is $7.6 billion, up from $5.5 billion when we wrote about them last quarter. The reason for the substantial increase is that in August, U.S. Steel received an unsolicited bid of $35 per share (cash and stock) from competitor Cleveland-Cliffs Inc. Their total liabilities (excluding deferred income taxes) less current assets are $1.2 billion, so we would put the enterprise value at $8.8 billion. 

For the third quarter of 2023 (release, 10-Q), adjusted EBITDA was $578 million, udown from $804 million in the prior quarter. That puts the EV/EBITDA at 3.8x using this quarter or 3.6x using the last nine months' results (annualized). 

For the current year-to-date, the company has generated cash from operations of $1.7 billion but has spent $1.9 billion on capital expenditures. They have borrowed $172 million, repurchased $175 million of stock, and drawn down cash by $280 million.

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 less than 4x EBITDA and your market capitalization is two-thirds of book value. Those are strong signals from the market not to be investing in capacity.

One interesting commonality to notice is that whether you look at U.S. Steel or Enterprise Products Partners, they are telling us - claiming - that the current investment cycles are not going to last forever. This is from the U.S. steel conference call:

We've been climbing a mountain of strategic CapEx. And now that we're coming down the other side of the mountain, we're not surprised so many see it won't be long before these new world-class assets generate strong free cash flow.

Another interesting comment was about the "tailwinds for American steel":

I mentioned the 3 global megatrends that will provide tailwinds for American steel and our business in the months and years to come. One is accelerating deglobalization. In a world impacted by conflicts like those in the Middle East and Ukraine and emerging from a global pandemic that stretched supply chains to the limit, we are witnessing a stark reversal after decades of globalization. The upshot enabled by legislation like the Bipartisan Infrastructure Law, the CHIPS Act and the Inflation Reduction Act, what we like to call the Manufacturing Renaissance Act. The United States is experienced once in a generation onshoring boom. The deglobalization boom means U.S. Steel's nearly 123-year history of producing steel that is mined, melted and made in the U.S.A. is paying significant dividends, with more to come and significant room for continued growth in North American steel demand. Fundamental to the deglobalization trend is the U.S.A.'s achievement of energy independence. Between our strong segment in tubular steel and our line pipe products coming out of North America and flat-rolled, we are seeing and we will continue to see a robust order book supporting America's energy markets. Another megatrend is decarbonization. There is a strong global commitment to reducing greenhouse gas emissions. With our electrical steels that are empowering the transition to EVs plus our exposure to sustainable steelmaking at Big River, U.S. Steel is well positioned to harness the decarbonization trend.

We are skeptical of big capital expenditures at companies with depressed valuations, but that is our outsider, generalist view. Perhaps our friends at Enterprise Products, Warrior, and U.S. Steel look around and see that no one else is making significant investments in coal, steel, and pipeline capacity. Maybe these investments are a cinch?

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.

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

[We wrote about met coal producer Warrior a couple of weeks ago. Now it is time to take a look at quarterly results for other coal producers Peabody Energy (previously), Arch Resources, and Alpha Metallurgical Resources. Also, note: we are big fans of The Coal Trader for coverage of the coal producer stocks.] 

Peabody Energy
The market capitalization of Peabody is down to $2.8 billion versus $4 billion when we wrote about them in August 2022. Total liabilities less current assets are under $400 million, and current assets now exceed current liabilities plus long term debt. We would put the enterprise value at $3.2 billion now. For the first quarter of 2023 (10-Q), adjusted EBITDA was $391 million, down from $500 million in the fourth quarter. That puts EV/EBITDA at 2x (annualized). 

As of 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. One calculation that you could make is that the enterprise value is now about $1.30 per ton of proved and probable reserves.

During the first quarter, seaborne thermal sold for $97 per ton with a $51 cost per ton; seaborne met coal for $220 per ton with a $151 cost per ton; PRB coal for $14 per ton with a $12 cost per ton; and other U.S. thermal coal for $55 per ton with a $41 cost per ton. Once again, seaborne thermal coal was the most profitable segment in Q1, earning $164 million of adjusted EBITDA, with seaborne met right behind, earning $91 million in adjusted EBITDA. The U.S. thermal coal (PRB & other) earned $100 million for the 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.

Peabody reported "Available Free Cash Flow" (AFCF) for the quarter of $262 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 24% (annualized). Some critics have pointed out that Peabody is a laggard compared with other miners in terms of cost inflation. The Coal Trader says:

"The companies who are able to manage costs will be most capable of maintaining positive operating margins no matter what the fundamental supply/demand situation looks like. These companies will therefore provide superior shareholder returns over time and will begin to separate themselves from their peers. Right now, they all sort of look the same and they’re all sort of valued more or less in the same range, in terms of EV/FCF metrics. But I think we’re starting to see some clear hints of who can separate themselves from the pack, and it might be easier to simply pick out the laggards and avoid them at all costs."

He puts Peabody in the laggard category, given how its costs per ton jumped dramatically in the first quarter. We agree with his notion that mineral producers with lower costs and lower capex requirements will outperform going forward. (That is why it was so important to look at capex growth versus production growth for our U.S. shale and Canadian oil producers this quarter.) Maybe one thing to mention though 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 is down to $2.1 billion. As of their Q1 2023 earnings report, total liabilities less current assets are around $100 million, putting the enterprise value at $2.2 billion. Their current assets exceed their current liabilities plus long term debt. For the first quarter of 2023 (10-Q), adjusted EBITDA was $277 million, which puts the EV/EBITDA at 2x (annualized). 

Adjusted EBITDA for 2022 was $1.26 billion, which is an EV/EBITDA on the current valuation of 57%. Last year they spent $493 million repaying debt, paid $456 million of dividends, and $157 million on share repurchases. Capital expenditures were $173 million compared to $133 million of depreciation.

For the first quarter, the pace of adjusted EBITDA was obviously a little lower (annualizing to $1.1 billion). For the quarter, they spent $31 million on capex (compared with $35 million of depreciation), repaid $71 million of debt, paid $67 million of dividends, and bought back $21 million of stock.

The Coal Trader points out that Arch did a very good job with lowering their cash cost per ton of met coal production in the first quarter of 2023. He says that Arch and Warrior should be the low cost met coal producers in the U.S. and that Arch is the best buy and hold producer if you do not want to have to think too hard.

Alpha Metallurgical Resources
The market capitalization of Alpha is down to $2 billion. As of their Q1 2023 earnings report, total liabilities less current assets are negative $300 million, putting the enterprise value at only $1.7 billion. For the first quarter of 2023 (10-Q), adjusted EBITDA was $354 million, which puts the EV/EBITDA at 1.2x (annualized).

Adjusted EBITDA for 2022 was $1.7 billion, which is an EV/EBITDA on the current valuation of 100%. Last year, they spent $451 million repaying debt, $13 million of dividends, and $522 million repurchasing stock. Capital expenditures for the year were $164 million compared to $108 million of depreciation.

For the first quarter, the pace of adjusted EBITDA was obviously a little lower (annualizing to $1.4 billion). For the quarter, they spent $74 million on capex (compared with $29 million of depreciation), paid $86 million of dividends, and bought back $145 million of stock. With all the repurchases, the share count is down 18.6% year-over year. Since starting its share buyback program five quarters ago, Alpha has repurchased 23% of total shares outstanding.

They have 323 million tons of met coal reserves, all in West Virginia and Virginia, and they account for around one-fifth of U.S. met coal production. That's an enterprise value of $5.26 per ton of U.S. met coal.

Coal Trader says that he agrees with Alpha's management that it is "criminally undervalued" but that they may not occupy as favorable a position on the cost curve as Warrior and Arch. Last week, he posted a writeup of a site visit to Alpha which is very interesting. He says that the Alpha CEO reads his coal Substack!

U.S. Steel
While obviously not a coal producer, U.S. Steel is one step down, vertically, from the production of metallurgical coal, and we have mentioned them in the past as a possible Cheap Cyclical (see also). In our review of Capital Returns, we mentioned that The Coal Trader had made an interesting comment about the relative capital cycle position of the coal producers versus the steel companies:

"[M]y preference is to maintain a bullish stance on the supply-constrained segment of the supply chain, specifically focusing on metallurgical coal and metallurgical producers. If necessary, I will hedge my position by shorting the oversupplied segment, which includes steel companies. While steel companies typically have strong balance sheets, similar to metallurgical producers, they have been investing heavily in capacity additions in an attempt to lower carbon emissions from basic oxygen furnace (BOF) production towards electric arc furnace (EAF) production, especially in North America and Europe. This is the classic Capital Returns cycle at play and if you haven’t read the book I highly recommend it."

We do not like heavy capital investments! (Unless we are in the position of getting a royalty on gross revenue.) U.S. Steel spent $740 million on capex in Q1 compared with $350 million the prior year quarter. That is quite a heavy lift compared with Q1's reported $200 million net income and $427 million of adjusted EBITDA. There is something quite unsatisfying about spending $2.1 billion over the trailing four quarters on capex while CFO was $2.9 billion and your market capitalization is only $4.9 billion. Not to mention the fact that U.S. Steel is trading for less than half of book value - that is a strong market signal not to be investing.

Peabody Energy Corp. - Q2 2022 Results ($BTU)

We have written about Peabody Energy many times over the years - mostly as a short idea. In July 2015, their subordinated debt was trading for around 10 cents on the dollar. For the third quarter of 2015, Peabody lost $350 million, had $9 billion of net debt, and a de minimis market capitalization.

The situation is quite a bit different now. For the second quarter of 2022, Peabody earned $410 million on $1.3 billion of revenue and had free cash flow of $420 million. Net liabilities are now only $700 million and the market capitalization is $4 billion, for an enterprise value of $4.7 billion. So we are talking 2.5x annualized earnings and a 36% annualized FCF/EV yield.

As of the end of 2021, Peabody had 2.1 billion tons of proven coal reserves and 374 million tons probable. The proved reserves were comprised of 100 million tons seaborne thermal, 100 million seaborne met coal, 1.8 billion in the powder river basin, and 150 million tons of other U.S. thermal coal. One calculation that you could make is that the enterprise value is under $2 per ton of proved and probable reserves.

So far this year, seaborne thermal has been selling for $78 per ton with a $43 cost per ton; seaborne met coal for $300 per ton with a $131 cost per ton; PRB coal for $12 per ton with a $12 cost per ton (i.e. breakeven); and other U.S. thermal coal for $50 per ton with a $37 cost per ton.

Seaborne met coal has been the most profitable segment, earning $481 million the first half of this year. Seaborne thermal has earned $267 million. The PRB earned only $6 million, and other U.S. thermal has earned $112 million. 

As we've noted in the past, Powder River basin coal trades at a huge discount because it has a lower heat content than Appalachian coal and it is further from customers. The best Appalachian coal sells for 10x more per ton than PRB coal. Peabody's largest segment (by coal tons in reserve) is operating at breakeven profitability.

Something that has been troubling me about names like Peabody and U.S. Steel is that, while they are making tons of money right now, they do not have a history of consistent profitability. Peabody obviously went bankrupt, and U.S. Steel lurches from boom to bust.

These cheap cyclicals are printing money, but we can't help but wonder whether they are too junky, and a distraction from what we really want to own. Recall what Dantes says in the Count of Monte Cristo:

"I make three assortments in fortunes — first-rate, second-rate, and third-rate fortunes. I call those first-rate which are composed of treasures one possesses under one’s hand, such as mines, lands, and funded property, in such states as France, Austria, and England, provided these treasures and property form a total of about a hundred millions; I call those second-rate fortunes, gained by manufacturing enterprises, joint-stock companies, viceroyalties, and principalities, not drawing more than 1,500,000 francs, the whole forming a capital of about fifty millions; finally, I call those third-rate fortunes, composed of a fluctuating capital, dependent upon the will of others, or upon chances which a bankruptcy involves or a false telegraph shakes, such as banks, speculations of the day—in fact, all operations under the influence of greater or less mischances, the whole bringing in a real or fictitious capital of about fifteen millions."

We are really interested in finding royalties and tollbooth businesses that we can hold through a significant coming inflation. An operation under the influence of greater or less mischances is something that we may be forced to sell because of poor capital allocation by or other disagreements with management. That would expose us to loss or to paying taxes on partly illusory (nominal) capital gains.

We should do better over time with investments that have lower volatility of operating profits and the highest percentage of revenue returned to shareholders, provided that we buy them at attractive prices. Remember our discussion of hydrocarbon royalties and pipelines? Profits that fluctuate into the red are signs of weak business models and poor competitive position.

Royalty trusts never lose money, by definition. Pipelines basically never lose money. The cigarette companies may have to take a non-cash writeoff of a stupid acquisition, but their operations are always profitable.

Public sector employees (university professors with tenure, as an example) do very well for themselves, when you consider that they are paid public sector wages and are selected for a lack of interest in wealth creation. This may be because of the lack of volatility in their earnings - they are never unemployed. 

This is a theme worth exploring further - slow, boring consistency as a path to long-term survival.

Morning Earnings: Peabody Energy ($BTU)

Peabody Energy (BTU, previously) reported results. Highlights:

• In the fourth quarter, the company generated $438.4 million of operating cash flow and used $11.8 million of investing cash flow (net of cash receipts from Middlemount and other related parties of $36.3 million), resulting in Free Cash Flow of $426.6 million.
  
• During the quarter, the company continued to make progress on its debt reduction activities. The company retired $154.4 million of senior secured debt through open market repurchases. The company also completed multiple debt-for-equity exchanges and issued 3.3 million shares of common stock in exchange for $45.4 million of senior secured notes. 
• ...approximately $420 million of debt retirements year to date, more than 26% of debt outstanding at the start of the year.
  
• During the fourth quarter, the company sold an additional 7.7 million shares of common stock under its previously announced "at-the-market" equity offering program (ATM), raising net cash proceeds of $92.6 million and resulting in 7.7 million shares remaining available under the ATM program.
• Cost per ton are anticipated to increase compared to the prior year as a result of higher royalties and fuel prices, in addition to incremental costs to increase near term production.

Our first post ever about old Peabody (pre-bankruptcy) in 2015 when it had subordinated debt trading at a yield to maturity of 40%. How things have changed. Now Peabody is free cash flow positive, deleveraging, and has debt trading close to par.

Peabody's current market cap is $1.9 billion, and I count $2.2 billion of net debt, for a total enterprise value of $4.2 billion. The FCF/EV yield is 41%. I think we could call that a cheap cyclical! 

With Peabody's $420 million of cash from operations in 2021, they spent $165 million in capital expenditures, a reinvestment ratio of 39%. In Q4, they reinvested only 10% (net) of their operating cash flow in capex. This is the same pattern we saw at the integrated oil majors, which are investing less than half of their operating cash flows in maintaining production. 

It is amazing watching these natural resource management teams - Canadian oil majors are a great example - so scarred by the recent bear market that they want to run basically deleveraged companies. They're using free cash flow to pay off debt with negative real yields!

Peabody Energy Options Contract Adjustment

On March 17, 2017, the United States Bankruptcy Court for the Eastern District of Missouri Eastern Division confirmed the Second Amended Joint Chapter 11 Plan of Reorganization (“Plan”) for Peabody Energy Corporation (BTUUQ). The Plan became effective on April 3, 2017, and BTUUQ shares were canceled.

Effective April 3, 2017, existing BTUUQ options are adjusted to no longer call for the delivery of Peabody Energy Corporation shares upon exercise.

"Judge Announces Intention To Confirm Peabody Energy Plan Of Reorganization, Paving Way For Emergence" $BTUUQ

Peabody Energy announced today that the judge presiding over the company's Chapter 11 process in United States Bankruptcy Court for the Eastern District of Missouri has ruled that he intends to confirm the company's amended plan of reorganization after finalization of language regarding a settlement with the U.S. Department of Justice.

The plan, which received overwhelming support from creditors with an overall approval rate of 93 percent and unanimous acceptance by all 20 voting classes, articulates Peabody's strategy to emerge from the Chapter 11 process with a strong balance sheet, well positioned to build a successful future for the company's stakeholders. Peabody expects to emerge from Chapter 11 in early April 2017, less than one year after commencing the Chapter 11 process.

Naturally, there is still a bid of $1.78 for the stock.

Peabody Energy Prices $950 Million Term Loan

The term loan is expected to close on April 3, 2017, concurrent with the anticipated effective date of Peabody Energy’s plan of reorganization and subject to court approval. The proceeds from the term loan will be used to fund a portion of the distributions to creditors provided for under the plan of reorganization.

"Peabody to Put Restructuring Plan to Creditor Vote"

"Coal miner Peabody Energy Corp. won bankruptcy-court approval to put its restructuring plan to a creditor vote in hopes of exiting chapter 11 protection in the coming months."

Peabody Energy Files Joint Plan of Reorganization of Debtors and Debtors in Possession $BTU $BTUUQ

Unsecured Subordinated Debenture Claims (Class 8A)
i. Classification:  Class 8A consists of all Unsecured Subordinated Debenture Claims against PEC.
ii. Treatment:  In accordance with the provisions in the 2066 Subordinated Indenture and section 510(a) of the Bankruptcy Code, holders of Unsecured Subordinated Debenture Claims have no right to receive any Distributions and, therefore, in accordance with the terms of the 2066 Subordinated Indenture, shall receive no recovery under the terms of the Plan until holders of General Unsecured Claims are paid in full.
iii. Voting:  Holders of Claims in Class 8A are deemed to have rejected the Plan pursuant to section 1126(g) of the Bankruptcy Code, and are not entitled to vote to accept or reject the Plan.

PEC Interests (Class 11A)
i. Classification:  Class 11A consists of all PEC Interests.
ii. Treatment:  PEC Interests shall be extinguished, cancelled and discharged as of the Effective Date, and holders of PEC Interests shall neither receive nor retain any property or Distribution in respect of such Interests.
iii. Voting:  Class 11A is Impaired.  Holders of PEC Interests are deemed to have rejected the Plan pursuant to section 1126(g) of the Bankruptcy Code, and are not entitled to vote to accept or reject the Plan.

Wow - opening bid from the company is 0 for the subordinated notes and 0 for the equity. Will be interesting to see what those do tomorrow, they've had big rallies!

Peabody Energy Requests Extension, Gives Updates

Update in the extension request that was just filed:

The Debtors and their advisors have also dedicated significant time and resources to, among other things the following:

a)Negotiating the Plan with various creditor groups, including the Debtors' lenders party to the First Lien Credit Agreement or their successors or assigns (the "First Lien Lenders"), and an ad hoc group of senior unsecured noteholders (the "Ad Hoc Noteholders"), an ad hoc group of noteholders for the Debtors' 10.00% senior secured notes due March 2022 (the "Second Lien Noteholders' Group"), and the committee for the unsecured creditors (the "Creditors' Committee");

Notice they don't mention any negotiation with the subordinated noteholders or the equity!

"Against this backdrop of achievement, and in recognition of the complex issues still facing the Debtors, the Debtors request an order further extending the Exclusive Periods. The Debtors are engaged in active and ongoing negotiations with, among others, the Debtors' First Lien Lenders, Ad Hoc Noteholders, the Second Lien Noteholders' Group and the Creditors' Committee. The Debtors have made considerable progress in negotiating the Plan and currently intend to file the Plan by December 14, 2016. However, in an abundance of caution and in case unanticipated delays arise, the Debtors hereby seek an extension of their Exclusive Periods."

I suspect that the plan will be leaving unsecured creditors significantly impaired, and so will not provide for any distributions to the subordinated notes (currently trading at 20!) or the equity.

"Peabody debt dispute fizzles as coal prices rise" $BTU $BTUUQ

Story:

On Wednesday, Peabody said the company was working to resolve the dispute that pitted its secured lenders against unsecured creditors, including distressed debt hedge funds Aurelius and Elliott, who were seeking a larger share of Peabody's assets in the reorganization.

"The parties are working to settle the (debt) issue as part of broader negotiations regarding the plan of reorganization," Peabody spokesman Vic Svec said in an emailed statement.

Peabody expects to file its reorganization plan by mid-December and hopes to exit bankruptcy within a year of its April 2016 filing, Svec said.

The unsecured debt is still trading in the high 50s. That's a substantial valuation hole to make up (don't forget accrued interest) before even the subordinated notes will be in the money.

Peabody Short Squeeze $BTUUQ

Over the past week there has been a monster squeeze in the delisted shares of bankrupt Peabody Energy. They had been trading at about $1.70 and are now $17. This 10x increase has increased the equity market capitalization from $31 million to $310 million.

The bonds have also rallied, with the unsecured debt now at about 50 and the subordinated notes at 23 cents on the dollar.

The company is massively indebted... which is why it filed for bankruptcy in the first place. There are $3.7 billion of the unsecured notes all trading at about 50 cents on the dollar. That indicates a $1.87 billion hole before the subordinated debt would be in the money. (And that doesn't count six months of accrued interest on the unsecured debt, either.)

The $367 million of subordinated notes trading at 23 represents a value hole of $268 million. The current equity price does not make sense to me in light of the significant (multiple billions of dollars) degree that the credit markets perceive the notes to be out of the money.

Consensus has been that the equity is not in the money. Hence the company's disclosure in its Monthly Operating Report:

It is uncertain at this stage of the Chapter 11 Cases if any proposed plan of reorganization would allow for distributions with respect to Peabody Energy equity or other securities. It is likely that Peabody Energy equity securities will be canceled and extinguished upon confirmation of a proposed plan of reorganization by the Bankruptcy Court, and that the holders thereof would not be entitled to receive, and would not receive or retain, any property or interest in property on account of such equity interests. In the event of cancellation of Peabody Energy equity or other securities, amounts invested by the holders of such securities would not be recoverable and such securities would have no value. Trading prices for Peabody Energy's equity or other securities may bear little or no relationship during the pendency of the Chapter 11 Cases to the actual recovery, if any, by the holders thereof at the conclusion of the Chapter 11 Cases. Accordingly, Peabody Energy urges caution with respect to existing and future investments in its equity or other securities.

Also, the view that the equity is out of the money seems to have led to a significant amount of selling call options. A squeeze started last week, and then a hedge fund filed a 13D that poured gas on the fire:

The Reporting Persons purchased the securities of the Issuer reported herein based on their belief that such securities are undervalued and represent an attractive investment opportunity. Depending upon overall market conditions, other investment opportunities available to the Reporting Persons, and the availability of securities of the Issuer at prices that would make the purchase or sale of such securities desirable, the Reporting Persons may endeavor (i) to increase or decrease their respective positions in the Issuer through, among other things, the purchase or sale of securities of the Issuer on the open market or in private transactions or otherwise on such terms and at such times as the Reporting Persons may deem advisable and/or (ii) to enter into transactions that increase or hedge their economic exposure to the Shares without affecting their beneficial ownership of Shares. The Reporting Persons are in the process of retaining legal and financial advisors to assist them in seeking the formation of an official equity committee and to preserve and realize on the substantial value of the Shares. In addition, the Reporting Persons intend to contact and speak with other holders of the Shares for the foregoing purposes.

It's tough for anyone to express the view that the shares are overpriced (except longs, who could just sell the shares). The options are "closing trades only" because the equity was delisted after the bankruptcy filing, and the cost to borrow the stock is 100% annual!