Thursday, May 11, 2023

Warrior Met Coal, Inc. ($HCC)

We wrote about coal miner Peabody Energy last year a couple times, but it is time to start looking at the other miners, too: Arch Resources, Alpha Metallurgical, and today's subject: Warrior Met Coal (HCC), which announced its results last week:

Warrior reported net income for the first quarter of 2023 of $182.3 million, or $3.51 per diluted share, representing a 25% increase over net income of $146.2 million, or $2.83 per diluted share, in the first quarter of 2022. Adjusted net income per share for the first quarter of 2023 was $3.57 per diluted share, compared to adjusted net income per share of $2.97 per diluted share in the first quarter of 2022, representing a 20% increase. The Company reported Adjusted EBITDA of $259.4 million in the first quarter of 2023, compared to Adjusted EBITDA of $243.8 million in the first quarter of 2022, representing a 6% increase. [...]

The Company generated cash flows of $192.9 million from operating activities in the first quarter of 2023, compared to $70.1 million in the first quarter of 2022. Capital expenditures and mine development for the first quarter of 2023 were $82.6 million, resulting in free cash flow of $110.3 million. Free cash flow was $60.6 million higher than the first quarter of 2022 and reflected higher sales volumes offset partially by higher capital expenditures and mine development.

The current market capitalization of Warrior is $2 billion. They have about $725 million in net current assets, so the EV is now $1.25 billion. The FCF/EV yield is now 35%, and the EBITDA/EV is 83% (both annualized) based on first quarter figures. (For the past three years, EBITDA was $1 billion (2022), $500 million (2021) and $110 million (2020). Something interesting about mining companies is that when oil prices and diesel fuel costs fall, the cost of production falls too.)

As Warrior has been earning money, the enterprise value has been falling. When we looked in March, about six weeks ago, the EV was $1.3 billion. Valuations based on this quarter's profit and cash flow figures would obviously require profits to stay steady at current levels, which would essentially mean a similar price for met coal, although they could also earn the same amount by selling more at a lower price. For the first quarter, their average realized price for met coal was $283 per ton. 

The price of Hampton Roads met coal (which is high-vol, a lower grade) is $207.50 per ton. Australian coking coal, which is a more similar quality coal to what Warrior produces, is selling for $246/ton. As they describe it:

As a result of our high quality coal, our realized price has historically been in line with, or at a slight discount to, the Platts Premium Low Volatility ("LV") Free On Board ("FOB") Australia Index Price ("Platts Index"). Our HCC, mined from the Southern Appalachian portion of the Blue Creek coal seam, is characterized by low sulfur, low-to-medium ash, and LV to mid-volatility ("MV"). These qualities make our coal ideally suited as a coking coal for the manufacture of steel.

What is interesting is that if you look at the Australian met coal futures, the price is above $250/ton through the end of next year. The cash cost of production this quarter was $131 per ton and they sold 1.8 million tons. Corporate overhead (besides COGS) was about $14 per ton. Even at lower met coal prices than $283 they are still making money - all the way down to a breakeven of around $145 per ton or so. And since the company has net cash, we do not need to worry as much about periods of time when prices are less robust.

Their two operating mines (No. 4 and No. 7) have 89 million tons of reserves. The Blue Creek mine, which the company is currently developing, has 107 million tons of reserves and resources. So the aggregate of almost 200 million tons of coal would be almost 30 years of production at current levels, and represents an enterprise value of around $6 per ton.

Warrior's assets once belonged to Walter Energy, which was a 2014 short idea, when we said, "management that won't use a $378 million market cap as a currency to retire debt trading in the 50s is going to crash the plane into the mountain with full afterburners on." The situation has changed a great deal subsequently.

The new fund manager of Third Avenue Value has made Warrior his second largest position (after Tidewater offshore drilling!). Here is how he describes the valuation:

There’s $500 million in net cash on the balance sheet, $200 million in excess inventories and significant tax-loss carryforwards remaining. There’s also Blue Creek, which we think is reasonably valued at the company’s NPV estimate of $1 billion. That all basically covers the current market cap.

That leaves roughly zero value being ascribed to the producing assets, which on a normalized basis should produce 7 to 8 million tons per year and – at current coal prices – should earn close to $1 billion in EBITDA annually. Even if you halve that EBITDA level assuming much lower normal coal prices, that’s a pretty attractive asset to have no value given to it. We think the math here gets us very quickly to playing with the house’s money, with a risk/return profile that is very much in our favor.

We really like royalties and we are always looking for first class assets. We generally don't favor producers as much but we are open to the idea that certain types of commodity producers are "royalty-like" if they have attributes such as: debt-free, front-loaded costs, low marginal cost.


CP said...

From The Coal Trader:
Things are just beginning to hum along for Warrior and I expect the market to finally come to grips with the fact this world class met miner is severely under-valued based on the long term potential of their best in class assets. I’ve always said that Warrior has the best assets and the worst labor pool, but the labor situation is quickly reversing course as the UMWA is on the way out. This will result in much better morale and long run operational performance as everyone in the coal industry knows that union mines are a huge hindrance to operational efficiency.

CP said...

Warrior Met Coal, Inc. today announced revised guidance for the fiscal year 2023 in light of the end of the labor strike and resulting incremental production volume as eligible employees return to work. Warrior is the leading dedicated U.S.-based producer and exporter of high quality metallurgical ("met") coal for the global steel industry.

As previously disclosed, on February 16, 2023, the labor union representing certain of the Company’s hourly employees announced that they were ending the labor strike that started in April 2021 and made an unconditional offer to return to work. The Company began the return-to-work process with the eligible employees who wished to return while continuing to engage in good faith efforts with the labor union to reach an agreement on a new contract. The return-to-work process has been ongoing since February and is now substantially complete.

Approximately 250 eligible union-represented employees returned to work following the end of the strike, and therefore the Company adjusted work schedules to maximize the amount of incremental production and revised the budget and outlook for the full year. The incremental production and sales volume is approximately 500,000 short tons, primarily occurring in the second half of 2023. As a result of the incremental volumes, the Company has revised its overall outlook and financial targets for 2023.

CP said...

Warrior reported net income for the second quarter of 2023 of $82.1 million, or $1.58 per diluted share, a decrease from net income of $297.0 million, or $5.74 per diluted share, in the record setting second quarter of 2022. Adjusted net income per share for the second quarter of 2023 was $1.63 per diluted share, compared to adjusted net income per share of $5.87 per diluted share in the second quarter of 2022. The Company reported Adjusted EBITDA of $130.0 million in the second quarter of 2023, compared to Adjusted EBITDA of $431.2 million in the second quarter of 2022. Warrior’s quarterly sales volumes rose 15% to 1.8 million short tons and the Company ramped up production to 1.9 million short tons, the largest level of activity since the first quarter of 2021 and a strong marker of its business momentum. While Warrior experienced strong volumes, the quarter was impacted by softening steelmaking coal prices as Warrior's average net realized price decreased from an unprecedented $403.95 per short ton in the record second quarter of 2022 to $208.56 per short ton.

CP said...

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.

While the Company originally planned on a single channel to transport coal from the Blue Creek mine via an overland belt to a third-party owned and operated barge loadout facility, it now plans to build a belt conveyor system to a railroad loadout to transport the majority of the coal which is expected to de-risk a single channel to market, lower operating cost and move volumes faster to the port. Warrior will also build and operate a barge loadout itself rather than utilizing a third-party provider. The Company believes that the potential economic benefits associated with this scope change should provide Warrior with an inherently robust and cost competitive outbound logistics model that will provide additional flexibility to manage alternative transportation methods. The inclusion of the benefits and incremental capital expenditures relating to these specific scope changes did not have a material impact to the project economic metrics of net present value ("NPV") and internal rate of return.

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.