Warrior Met Coal: 23% FCF Yield With 70% Upside Potential In FY21

Warrior Met Coal: 23% FCF Yield With 70% Upside Potential In FY21

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Strong FCF even under current met coal price.

Solid balance sheet and liquidity position.

Bargain price; the company trades at a forward EV/EBITDA of 2.9x versus its long-term average of 3.5x.

The shares are oversold during the COVID-19-related market crash due to low coal price.

Warrior Met Coal (HCC) is a long-life and high-margin quality coking coal producer in the U.S. (8mt p.a.) The company trades at a P/E of 4.2x and 2.9x EV/EBITDA with very low debt. The Blue Creek growth project can be funded without an equity raise and will approximately double free cash flow once completed in around five years. The management team has a strong track record of excellent capital management and operational efficiency.

Company Overview

The company operates two of the deepest underground mines in North America and also owns the undeveloped Blue Creek Energy project with potential to produce up to 3mt over 40+ years. Warrior has 110 million tons of met coal reserves, indicating ~15 years of production remaining based on a production rate of ~8mt.

2019 result

HCC finished 2019 with record annual sales volumes of 8.5mt of production, above the initial guidance of 7.5-7.9mt, and managed sales for 4Q19 at the top end of guidance despite a weaker coal market, which is a reflection on the company’s high-quality product/geographical mix in comparison with some peers.

As part of its continuous capital management program, the company retired $132 million of debt, paid $230 million of special dividend to shareholders, and bought back $70 million of shares.

Blue Creek go-ahead

HHC officially announced its plans to invest $550-600 million over the next 5 years to bring on ~4.3mt/year by 2025. The company highlighted a 30% IRR with all-in cash cost of around $65-75m/t. The project, if completed, will increase HCC’s production capacity by 54% and will add around 50 years of expected production life. The mine is also expected to have very competitive cost position globally.

(Source: Q4 2019 Results Presentation, February 19, 2020)

The Blue Creek mine is forecast to produce 4.3mt/year for the first 10 years, with an option to scale production to roughly double (total of 8.5mt). The project has an estimated 5-year construction period, with the majority of the capex due in 2022-2024 and a smaller contribution of $25m expected in 2020. The project has total capex of $550-600 million, and HCC commented that it will likely use a combination of financing options, including cash on hand ($193 million), cash flows from operations, undrawn facility (~$100 million) and an option for lease financing ($115 million).

(Source: Warrior Met Coal Blue Creek Presentation, February 2020)

(Source: Warrior Met Coal Blue Creek Presentation, February 2020)

Coal pricing dynamics support coal price recovery

According to CRU, coking coal prices finished 2019 at a three-year low ($134/t) as weak demand from the steel industry, port restrictions on coal intakes at Chinese ports and rapidly improving coal supply weighed on coal prices. Since then, prices have risen ($158/t) due to significant supply disruptions in China caused by COVID-19 and also due to supply issues in major exporting countries. Despite the recent increase in coking coal prices, they remain below the 90th percentile of the global cost curve. Market conditions will improve from next year, and CRU forecasts the prices to average close to the 90th percentile in 2024 ($164/t). At the price of $164/t, HCC is expected to generate EBITDA and FCF of $477 million and $332 million respectively based on management’s guidance for FY20 sales volume, costs and capex.

Costs and capital expenditure

HCC has a highly variable cost structure with key components linked to the Hard Coking Coal price, including labor, royalties and transport. Floors and ceilings are in place to protect the margins during downturns, as well as maintain significant leverage to the upside in pricing. Generally, mining-related expenses (including labor, raw materials, power, fuel, consumables, etc.) account for about two-thirds of the total costs, while the remaining one-third relates to royalties and the cost to transport coal from the mine to the port.

For 2020, management has guided for FOB cash cost of $88-93/st and capex of $125-145 million in 2020, with sustaining capital at $75-85 million.

Special Dividend

The company returned more than $1 billion of cash to shareholders in the form of a special dividend over the last three years. It expects to pay special dividend to shareholders when coal price remains about $193/mt. Thus, HCC’s shareholder-friendly capital management plan provides additional cash return to shareholders if coal prices outperform the current weak market expectation.

(Source: Q4 2019 Results Presentation, February 19, 2020)

Balance Sheet and Liquidity

According to Bloomberg, HCC had LTM cash of $208 million and long-term debt of $375 million, implying net debt of $167 million with no legacy pension or OPEB liabilities.

Liquidity stood at $324 million, which consists of cash on hand of $208 million and $116 million available under revolving credit facility. HCC has no near-term maturities, with the ABL facility due in October 2023.

Valuation

On a 12-18-month view for HCC, I forecast a 70% upside potential for investors based on its long-term average EV/EBITDA multiple of 3.5x and Bloomberg consensus forecast EBITDA of $321.9 million in FY21. The company also provides significant growth potential in production volume via its Blue Creek project and special dividend if the coal price remains above $193/mt. In addition, it offers around 2% of dividend (regular) yield at the current share price and expects to generate enough FCF to fund its growth capex.

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