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.