Warrior Met Coal Inc

NYSE:HCC

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon. My name is Kate, and I will be your conference operator today. At this time, I would like to welcome everyone to the Warrior Met Coal First Quarter 2023 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] This call is being recorded and will be available for replay on the Company's website.

Before we begin, I have been asked to note that today's discussion may contain forward-looking statements, and actual results may differ materially from those discussed. For more information regarding forward-looking statements, please refer to the company's press releases and SEC filings.

I have also been asked to note that, the company has posted reconciliations to of the non-GAAP financial measures discussed during this call in the tables accompanying the company's earnings press release located on the Investors section of the company's website at www.warriormetcoal.com. In addition to the earnings release, the company has posted a brief supplemental slide presentation to the Investors section of its website at www.warriormetcoal.com.

Here today to discuss the Company's results are: Mr. Walt Scheller, Chief Executive Officer; and Mr. Dale Boyles, Chief Financial Officer. Mr. Scheller, you may begin your remarks.

[Walt Scheller, Chief Executive Officer]

Thanks operator. Hello, everyone, and thank you for taking the time to join us today to discuss our first quarter 2023 results. After my remarks, Dale will review our results in additional detail, and then you'll have the opportunity to ask questions. We were pleased to deliver another extremely strong quarter reflected in our financial results and better-than-expected sales and production volumes. We entered the first quarter with optimism that strong customer demand, with facilitated drawdown of our inventories with the expectation of continuous improvement and performance at the McDuffie Terminal.

We've previously spoken about the performance issues at the McDuffie Terminal and have taken a number of actions to address them. Over the past few months, we've implemented several initiatives to improve the loading throughput at the terminal, including the allocation of personnel and resources. These initial efforts focus primarily on addressing maintenance and equipment reliability issues on belt conveyor systems.

We are pleased with the progress made so far, but we acknowledge that the Terminal's performance remains vulnerable and will require long-term support and attention from Warrior. One additional challenge is that, the terminal is undergoing a significant overhaul of its ship loader number one belt structure, which will remain out of service until the end of the second quarter.

We will continue to work closely with the Alabama State Port Authority to help achieve its objectives. In the interim, Warrior will ship small volumes from alternative ports to ensure timely deliveries for our customers at minimal extra costs. Our commitment to delivering sustainable results at the terminal remains unwavering.

From a market perspective, during the first quarter, the steel industry demonstrated a better-than-expected performance, as evidenced by a sustained increase in steel prices across North America, Europe and select Asian regions.

European steel producers, announced the restart of several previously idle blast furnaces and ramped up production, aided by notable correction in energy prices. China remained focused on reopening their economy and bolstering its crucial property sector, resulting in an encouraging rise in steel production during the first two months.

Additionally, China's decision to lift the ban on Australian coal imports, was confirmed during the quarter, although there have been limited transactions between the two countries so far. From a supply standpoint in the first quarter, the vulnerability of the global supply chain was on full display, as strong rains and a significant train derailment impacted Australian supply performance. These factors resulted in Australian exports trailing 2022's figures, by over 15% for the first two months of the year.

As a result, it's likely that Australia could record its lowest exports, for the first quarter in over five years. Meanwhile, both Canada and the United States demonstrated robust performance during the same period, with both countries recording positive growth. In addition, we note the remarkable increase in Mongolian exports to China, which have surged by a staggering 470% in the first two months of this year.

As the first quarter due to a close, global supply availability showed signs of improvement especially from Australia, resulting in a more balanced market. This was evident by a steady correction in pricing. Our primary index, the PLV FOB Australia, dropped by over 23% from its peak of $354 per short ton in February, to $273 per short ton by the last day of March.

In contrast the PLV CFR China Index, experienced a comparatively modest decline of approximately 8% from its peak of $311 per short ton in early March to $286 per short ton, at the end of the month.

According to a recent report by the World Steel Association, global pig iron production increased by 3.1% and in the first three months of 2023, as compared to the same period last year. The production increase was mainly driven by a strong start for Chinese production, which grew by 7.6% during the period. Additionally, India continued its recent higher trend by growing 5.9% during the period.

As anticipated, production from the major European producers declined by over 8.9%, due to the implementation of numerous blast furnace idlings and production cuts that originated during the previous fourth quarter. Furthermore, Turkey steel production was significantly impacted by the tragic earthquake, that hit the southern part of the country in early February.

Our first quarter sales volume of 1.9 million short tons, was 73% higher than the comparable quarter last year. The increase was driven by the drawdown of coal inventory levels in the first quarter, due to the improved performance at the McDuffie Terminal, which enabled us to export more product. In addition, better-than-expected production, drove an increase in sales volume for the quarter.

Our sales by geography in the first quarter, were 52% into Europe 23% into South America and 21% into Asia. European sales continued to be strong with the blast furnace restarts that I previously mentioned, despite the economic headwinds facing the region. Production volume in the first quarter was better than expected, and totaled 1.8 million short tons compared to 1.5 million short tons in the same quarter of last year, representing a 14% increase. Both mines operated at higher capacity levels in this quarter with a higher headcount compared to the prior year's comparable quarter. Last year, at this time Mine 4 was being restarted and both mines operated at reduced capacity.

During the first quarter, we spent $83 million on CapEx and mine development. CapEx spending was $68 million, which included $28 million on the Blue Creek project. Mine development spending was $15 million during the first quarter. We expect development at Mine 4 will be completed in the next few months, while development at Blue Creek will continue over the course of the project.

In February, the labor union representing certain of our hourly employees announced they ended their strike and unconditionally offered to return to work. We started – the return-to-work process, which primarily includes drug testing and return-to-work physical and safety training. The return-to-work process is still ongoing, as it takes time to process all of the eligible employees through the testing and training. While we expect the return-to-work to take a little more time, we're reviewing and adjusting our work schedules to accommodate the eligible employees returning to work.

The number of anticipated eligible employees participating in the return-to-work process is approximately 300. A little more than one-third of those employees have already returned to work. We expect that all of our current employees will continue to work full time at the mines in addition to those returning to work.

With the returning employees, we're in the process of revising our internal budgets and outlook for the remainder of the year and expect the process to be completed by early June. At that time, we expect to provide an external update to the investment community on our 2023 guidance targets. Our initial assessment indicates that the majority of any incremental production volume will primarily start to occur in June and impact the second half of the year.

With the expected incremental production, we expect to capitalize on opportunities to sell the incremental volume to our existing customers or opportunistic spot sales. Meanwhile, we continue to negotiate good faith the new labor contracts while the eligible employees return to work.

During the first quarter, we continued to make substantial progress on the development of Blue Creek and our work remains on schedule. Specifically, the production slope service shaft and return ventilation shafts are a little more than halfway completed at this point. We recently broke ground on construction of the bathhouse and mine offices with the initial foundation work underway. From a financial standpoint, we invested $28 million in the development of Blue Creek during the first quarter. We expect to be making further investments on a larger scale during the remainder of this year.

Other key time line tasks are underway in various stages of obtaining bids, contract negotiations and revisions to project specifications. We plan to continue providing updates during our quarterly earnings calls throughout the year.

I will now ask Dale to address our first quarter results in greater detail.

[Dale Boyles, Chief Financial Officer]

Thanks, Walt. For the first quarter of 2023 the company recorded net income on a GAAP basis of $182 million or $3.51 per diluted share, representing a 25% increase over net income of $146 million or $2.83 per diluted share in the same quarter of last year.

Non-GAAP adjusted net income for the first quarter, excluding the non-recurring business interruption expenses, idle mine expenses and other non-cash adjustments was $3.57 per diluted share.

This compares to an adjusted net income of $2.97 per diluted share in the same quarter of 2022. These increases quarter-over-quarter were primarily driven by higher sales volumes, partially offset by lower average net selling prices and higher inflation.

We reported adjusted EBITDA of $259 million in the first quarter of 2023, compared to $244 million in the same quarter of last year, representing a 6% increase. The quarterly increase was primarily driven by a 73% increase in sales volume, partially offset by lower average net selling prices and the impact of inflation on supplies and electricity.

Our adjusted EBITDA margin was 51% in the first quarter of 2023, compared to 64% in the same quarter of last year. Total revenues were $510 million in the first quarter of 2023, compared to $379 million in the first quarter of last year. This 35% increase was primarily due to the 73% increase in sales volume, partially offset by lower average net selling prices.

Other revenues were higher in the first quarter of 2023, primarily due to the fact that the prior year included a mark-to-market loss of $13 million on our gas hedges, offset partially by a decrease in revenues due to lower natural gas prices.

Platts Premium Low Vol FOB Australian Index price on average was $131 per short ton lower in the first quarter of 2023, compared to the same quarter of last year. The index price averaged $312 per short ton for the first quarter.

Demurrage and other charges reduced our gross price realization to an average net selling price of $257 per short ton in the first quarter of 2023, compared to $339 per short ton in the same quarter of last year. Demurrage and other charges were $4 million in the first quarter this year and were flat compared to last year's first quarter.

The charges were the result of temporary delays in vessel loadings, due to severe weather and port congestion in the first quarter of this year. Cash cost of sales were $232 million or 46% of mining revenues in the first quarter, compared to $134 million or 35% of mining revenues in the first quarter of 2022.

The increase of $98 million was primarily due to the 73% increase in sales volume, plus the impact of inflation. Inflation accounted for approximately $2 million of a higher cost or $1 per short ton higher than the fourth quarter, resulting from higher cost for supplies and electricity.

Cash cost of sales per short ton FOB port was approximately $119 in the first quarter, compared to a similar amount in the first quarter of 2022. Met coal prices were lower in the first quarter of this year, compared to the first quarter of 2022. This resulted in lower transportation and royalty costs on a per ton basis, which were offset by higher cumulative inflation, higher wages on a higher headcount that drove higher production plus slightly higher transportation cost for loading vessels through alternative ports during the quarter.

Transportation and royalty costs were 44% of our cost per ton in the first quarter, compared to 46% in the same quarter last year. Despite the higher variable cost and inflation, cash margins were $138 per short ton in the first quarter.

SG&A expenses were about $15 million or 2.8% of total revenues in the first quarter of 2023 and were higher than last year's first quarter, primarily due to an increase in non-cash stock compensation expenses. The interest income earned on our cash investments exceeded the interest expense on our outstanding notes and equipment leases during the first quarter of 2023, primarily due to our higher cash balances.

Our first quarter non-cash tax expense primarily reflects the utilization of our federal net operating losses or NOLs offset partially by the tax benefits for depletion and a tax benefit for foreign derived intangible income. We expect to continue to utilize our federal NOLs and tax credit carryforwards. We believe we may become a cash taxpayer in late-2023 or 2024 based upon our long-term forecast of met coal prices, sales volumes and performance.

During the first quarter, we incurred incremental nonrecurring business interruption expenses of $4 million, which were lower by 37% than last year and that were directly related to the then ongoing labor strike. These nonrecurring expenses were primarily for incremental safety and security, legal and labor negotiations and other expenses.

Turning to cash flow. During the first quarter of 2023, we generated $110 million of free cash flow this was due to cash flows generated by operating activities of $193 million, less cash used for capital expenditures and mine development costs of $83 million. The end result was cash flow conversion of 43% this quarter versus 20% in the first quarter of 2022. Free cash flow in the first quarter of 2023 was 122% higher than last year's first quarter, even though negatively impacted by a $69 million increase in net working capital from the fourth quarter of 2022. The increase in net working capital was primarily due to an increase in accounts receivable as a result of higher sales volume and the timing of sales as well as lower accrued expenses and accounts payable, partially offset by lower inventories.

Our total available liquidity at the end of the first quarter was a record $986 million, representing an increase of $33 million or 3% over the fourth quarter and consisted of cash and cash equivalents of $863 million and $123 million available under our ABL facility.

From a capital allocation standpoint, the company remains committed to return the excess cash to stockholders to increase stockholder value, while driving long-term growth with the investment in the development of our world-class Blue Creek reserves. We continue to demonstrate that commitment in the first quarter by increasing our fixed quarterly dividend by 17% and paying a special cash dividend of $0.88 per share.

Now turning to our outlook and guidance for 2023. We believe we are on track to achieve our targets outlined in the outlook section of our earnings release. As Walt indicated earlier at this point, we have not updated our internal budgets or external guidance to account for any changes in cost and volumes associated with the union represented employees returning to work.

I'll now turn it back to Walt for his final comments.

[Walt Scheller, Chief Executive Officer]

Thanks, Dale. Before we move on to Q&A, I'd like to make some final comments on our outlook. As we look forward, we anticipate ongoing stable demand for our products based on discussions with our diverse customer base. While China's steel production remains difficult to predict, our current view is that we'll correct during the year resulting in a decline in annual production year-over-year.

As restocking eases and the potential slowdown in the second half of the year begins to materialize, we expect steel prices to lose some or most of their recent gains. Additionally, we foresee that met coal pricing will face further downward corrections absent any other unforeseen disruptions primarily due to improving supply chain out of Australia and higher Mongolian exports into China.

As I said earlier, we expect the return-to-work process of eligible employees to continue through the end of May. We are revising our internal budgets and outlook for the remainder of the year and expect that process to be completed in early June.

At that time, we expect to provide an external update to the investment community on our 2023 guidance targets. Our initial assessment indicates that the majority of any incremental production volume will primarily start to occur in June and impact the second half of the year.

We expect the higher production volume in the second half of the year to result in higher sales volumes as well. We expect 2023 will be a significant turning point in the development of our world-class Blue Creek mine that will drive long-term stockholder value.

Later this year, we will begin groundbreaking for the larger infrastructure components such as the new coal preparation plant a bathhouse of mine offices and overland belt conveyor and a barge load out. We're excited to see the progress that will come this year as we expect to invest approximately $250 million on the project.

We're extremely excited about this organic growth project which will transform Warrior and allow us to build upon our proven track record of creating value for our stockholders.

As we have previously indicated we expect the first development tons from continuous mining units in the third quarter of 2024 with a Longwall scheduled to start up in the second quarter of 2026.

With that, we'd like to open the call for questions. Operator?

[Operator]

[Operator Instructions]. The first question comes from Lucas Pipes of B. Riley Securities. Please go ahead.

[Lucas Pipes, B. Riley Securities]

Thank you so much operator. Good afternoon, everyone and congrats on a terrific start to the year. My first question is in regards to the staffing levels today and your outlook on that. Could you comment when you would expect to be fully staffed? And in a way do you have excess labor after the end of the strike in February, or is that your expectation? Thank you very much for your comments on that.

[Walt Scheller, Chief Executive Officer]

Thank you, Lucas. Appreciate your question. And after we get the employees back they have decided to come back we will still be about 200 people short for or 150 to 200 short of where we were pre-strike. So we'll be continuing to hire aggressively throughout the year and probably into next year as we begin to look at Blue Creek as well.

So that's how we'll be doing that and that's one of the things we're looking at is exactly how many people, because we're in the process and like I said some of them have already come back and by the end of May or early June we expect to have the folks back that are going to make it.

[Lucas Pipes, B. Riley Securities]

Very, very helpful. Thank you for that. And when you think about that 150 to 200 headcount shortage, how would you bridge that? Is that attrition or retirements? Would appreciate any comments on what changed in the interim.

[Walt Scheller, Chief Executive Officer]

Lucas, I think we just had as the -- we striking miners whenever they -- we're total return to work I think we had some of them who for whatever their personal reasons were decided not to return whether they took employment at other operations, or whether they just retired, or for whatever reason personally they were just ready to move on.

[Lucas Pipes, B. Riley Securities]

That's very helpful. Thank you for that. And then shifting topics really quickly. Dale you commented on using up the federal NOLs either later this year or early 2024 and I wondered if you get to that situation could that have an impact on your capital return approach it could it make more sense at that point to have a greater share buyback for example? I would appreciate your thoughts on that. Thank you.

[Dale Boyles, Chief Financial Officer]

Good question. Thanks Lucas. Yes, as we've said before once we get through the NOLs, I think, we would probably have a more balanced fixed quarterly dividend with variable quarterly dividends combined with stock buybacks at some point. And we said, look, we're committed to returning excess cash even during the development of Blue Creek if there is excess cash available. So once we get past the NOLs, I think, we would have a more robust capital return program, including all of those different options.

[Lucas Pipes, B. Riley Securities]

Very helpful. Thank you. And then I'll squeeze in a market-related question. When I look at Platts met coal pricing as of last night FOB Australia PLV 229; CFR China delivered coal price 243. And when I think of kind of very roughly about a $30 freight rate from Mobil to China had come at a kind of net back price of 213 [ph], if you were to sell into China. So I wondered is this market open to you? And how would you approach the China opportunity today? Thank you very much.

[Walt Scheller, Chief Executive Officer]

Well, I think your numbers are kind of spot on with where everything is. And what we'll be looking at as we look at the remainder of the year and whatever our spot opportunities are we'll look for whatever is the best opportunity. And if that happens to be moving those tons into China at a little lower rate than we could -- than what we're doing from a contractual standpoint and that's what we'll have to consider. But we're looking at all those things right now.

[Lucas Pipes, B. Riley Securities]

Very helpful. Again, -- thank you very much and again, terrific work. Really appreciate it.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Dale Boyles, Chief Financial Officer]

Thanks.

[Operator]

[Operator Instructions] The next question is from Nathan Martin from The Benchmark Company. Please go ahead.

[Nathan Martin, The Benchmark Company]

Thank you, operator. Good afternoon, guys. Congrats on the quarter. Thanks for taking the questions.

[Walt Scheller, Chief Executive Officer]

Hey, Nathan.

[Nathan Martin, The Benchmark Company]

Walt, you made the comment that production was even better than expected in the quarter. And I know, I think for instance, it looks like Mine four production was up over 30% quarter-over-quarter. Was that really just better productivity or the ability to put more miners to work? And then maybe where are you applying the bulk of the union workers that have returned at this point? It would be great to get your thoughts there.

[Walt Scheller, Chief Executive Officer]

Well, the productivity was simply being able to run the longwall as much as we could and putting more CM units back in line. As far as where the employees that are coming back to work are going, those employees when they left were assigned to a certain mine and they returned back to that mine. And what we've seen is if you really consider us to be really for the most part three portals three big portals. It's about equally spread between the three as the people return to work. So Mine 4 will get about a third of the people and Mine 7 get about two-thirds roughly.

[Nathan Martin, The Benchmark Company]

Okay. That's helpful. And then maybe along the same lines, again, I understand you guys are waiting to update production shipment guidance for June. But as I think about the potential for an increase due to the return of some of the union workers, is there any CM lead work that would need to be done kind of ahead of a potential ramp to more nameplate capacity production?

[Walt Scheller, Chief Executive Officer]

No, really it's -- we've been -- since the strike started, we've really been running five days a week and the real opportunity here is to add on additional shifts. Our minds are skip constraint on how much coal they can get out per day and they've been running really well. So the real opportunity is finding -- you've got to find additional hours where you can mine. So that's what it really comes down to. And we're building all that in the budget right now.

[Nathan Martin, The Benchmark Company]

Got it. Makes sense. And then maybe shifting to the budget you just mentioned. As we think about Blue Creek CapEx, I think you commented on the last call Walt that you guys were still entering into some of the key large contracts and would be in a better position to update us later in the year. Maybe could you talk about what kind of progress you've had there? Any expectations on labor being sticky lead times that everybody is seeing kind of extend and possibility for any pressure on CapEx and then maybe when we could expect to get any updates? Appreciate it.

[Dale Boyles, Chief Financial Officer]

Thanks Nathan. This is Dale. I'll answer that one. We're still early on as we said in our prepared remarks, still working primarily on the slopes more than halfway down and we're going to be breaking ground some of the larger stuff later this year. So once we get those contracts, we'll have a better idea if there are any changes in cost, but that's going to come late probably in the year before we know that.

As we said, look for the last 15 months we've been seeing inflation in labor. We've seen it in supplies materials even beginning to see it in rate increases and electricity costs. So, we would expect some type of inflation, but it's a five-year project, so some of that will normalize or even out over that time and then we may have some scope changes as we get into all those specifics of the contracts with each of those major components, so still too early to tell.

[Nathan Martin, The Benchmark Company]

Well, I appreciate those thoughts Dale. And then maybe just one last thing. I mean strong cost performance I would say in the quarter guys despite some of those items you just mentioned, down quarter-over-quarter you've been with an increase in realized prices.

Some of that is just the one quarter lag on the rail side. I would expect that's probably a headwind in the second quarter. I just want to make sure I think about that correctly from a modeling standpoint.

[Walt Scheller, Chief Executive Officer]

That would be correct. You're right. Rail rates will go up in the second quarter based on the higher average met coal price in the first quarter.

[Nathan Martin, The Benchmark Company]

Okay, perfect. I appreciate the time. Best of luck good rest of the year.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Operator]

The next question is from Luther Lu of LMR Partners. Please go ahead.

[Luther Lu, LMR Partners]

Thank you. Hi Walt. You mentioned in the prepared remarks that there is a major repair at the McDuffie Terminal currently. Will that impact the second quarter shipment?

[Walt Scheller, Chief Executive Officer]

No, that impact occurred -- we're probably six weeks or more into that. It's the rails basically the rail and the belt system that the ship loader runs on needed to have a significant amount of structural work done.

And so we've been dealing with that for the last couple of months but the improvements in load rates at the number two ship loader have just been really strong and have allowed us to perform -- has allowed the port to perform in a manner that's allowed us to reduce inventory by a couple of hundred thousand tons.

So, we've been very satisfied with that. But it's critical for them to get that Ship 1 loader back up and running as well so that more than one vessel can be loaded at a time.

[Luther Lu, LMR Partners]

Okay. And one of the mines in Alabama right now is not producing much, but your peers is trying to put in long walls and ramp up production in 2024. Will the terminal be able to handle extra 2 million tons of annualized production in the current state?

[Walt Scheller, Chief Executive Officer]

That's why we need that number one ship loader back up and running Luther.

[Luther Lu, LMR Partners]

I see. Okay. And could you give us some color on just exactly how much the demurrage cost was per ton-wise is in the first quarter?

[Dale Boyles, Chief Financial Officer]

Well, it's $4 million in total. So, a couple of bucks a little less than a couple of bucks.

[Luther Lu, LMR Partners]

Okay. Got it. Thank you very much for the color.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Operator]

The next question is a follow-up from Lucas Pipes of B. Riley Securities. Please go ahead.

[Lucas Pipes, B. Riley Securities]

Thank you very much for taking my follow-up question. It's high-level market related. You have good insights into Europe, South America, Asia too. I wondered if you could maybe expand a little bit on your comments in the prepared remarks that you would expect pricing to continue to moderate. What are you seeing out of these different end markets? Would very much appreciate your color. Thank you.

[Walt Scheller, Chief Executive Officer]

Well, we're still seeing strong demand out of all those markets. But I guess what we're seeing is, it's the supply side of the equation where we're starting -- as I said with Mongolia increasing their shipping or their trucking into China just dramatically. And with -- it looks like Australia is starting to get their production or their transportation issues and production issues back in line. So I think we're going to have more supply available. And we've always -- we've been saying for quite a few quarters that we thought there would come a time when pricing would moderate. And even in our budget this year, I think our estimate was about $200. So we're not surprised at all with where the market is going as supply constraints seem to be easing. And I think that's -- we're just not really surprised with where it's headed right now. And even at two-third we expect a little more downward pressure.

[Lucas Pipes, B. Riley Securities]

That's very helpful. Appreciate the color and best of luck.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Operator]

At this time, there are no further questions. I will now turn the call back over to Mr. Scheller for any comments.

[Walt Scheller, Chief Executive Officer]

That concludes our call this afternoon. Thank you again for joining us today and we appreciate your interest in Warrior Met Coal.

[Operator]

Thank you. That concludes today's conference. Thank you all for participating. You may now disconnect.