Alliance Resource Partners, L.P. (ARLP) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2016 Alliance Resource Partners LP and Alliance Holdings GP LP Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference Mr. Brian Cantrell, Senior Vice President and Chief Financial Officer. Mr. Cantrell, you may begin.

Thank you, Andrea, and welcome everyone. Earlier this morning, we released 2016 second quarter earnings for both Alliance Resource Partners, or ARLP, and Alliance Holdings GP, or AHGP. And we'll now discuss these results, as well as our outlook for the balance of the year. Following our prepared remarks, we’ll open the call to your questions. Before we begin, a reminder, that some of our remarks today may include forward-looking statements that are subject to a variety of risks, uncertainties, and assumptions, which are contained in our filings from time to time with the Securities and Exchange Commission, and are also reflected in this morning's press releases. While these forward-looking statements are based on information currently available to us, if one or more of these risks or uncertainties materialize or if our underlying assumptions prove incorrect, actual results may vary materially from those we projected or expected. In providing these remarks, neither partnership has any obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. Finally, we’ll also be discussing certain non-GAAP financial measures. We have provided definitions and reconciliations of the differences between these non-GAAP measures and the most directly comparable GAAP financial measures at the end of the ARLP press release, and we refer you to ARLP’s website and the Form 8-K for a copy of the release that we filed this morning. Now that we're through with the required preliminaries, I'll turn the call over to Joe Craft, our President and Chief Executive Officer. Joe?

Thank you, Brian. Good morning, everyone. ARLP again delivered solid operating and financial performance in the 2016 quarter. Tons sold, revenues, net income, and EBITDA all showed significant increases over the sequential quarter. Through the first half of 2016, coal sales price realizations have exceeded our expectations due to our sales mix. Our cost control and efficiency initiatives have also led to lower than anticipated operating expenses and segment adjusted EBITDA expense per ton. As a result, year-to-date margins per ton are well above our initial expectations. Distributable cash flow for the 2016 quarter increased to $122.1 million, 42.3% higher than the sequential quarter. Distribution coverage also improved for the 2016 quarter to 2.3 times. We continue to anticipate coverage of at least 2.0 times during the second half of the year. As anticipated, ARLP's quarter-over-quarter and year-to-date comparative results have been negatively impacted by the well-documented challenging market conditions that coal industry has experienced this year. We along with our competitors made a strategic decision to reduce production volumes in response to this market, which was caused primarily by lower power demand, persistently low natural gas prices, and excessive utility stockpiles. For the first six months of 2016, production in the Eastern United States has dropped 28.9% compared to the 2015 period. During that same time period, our ARLP's coal production fell 13.9%. ARLP's sales volumes were also down by 24% and 22.8%, compared to the 2015 quarter and period respectively, causing our inventories to grow year-to-date to 4.2 million tons at the end of the 2016 quarter. Fortunately, we are beginning to see positive signals in the markets we serve as hot summer weather and rising natural gas prices are drawing utility inventories lower. Weather forecasts appear favorable, and the forward price curve for natural gas is positive for the balance of the year. We anticipate these factors will help us catch up on past due deliveries under our contracts. As a result, we are forecasting our sales volumes to increase approximately 4.5 million tons in the second half of 2016 compared to the first half. Buying activity picked up during the 2016 quarter allowing ARLP's marketing team to further strengthen its contract book by increasing price and volume commitments by approximately 5.2 million tons through 2019. ARLP is now essentially sold out for 2016 based on anticipated production levels and has also secured price and volume commitments for 2017, 2018, and 2019 of 24.3 million tons, 15 million tons, and 7.9 million tons, respectively. We are anticipating additional buying activity for 2017 and beyond. We will begin in earnest over the next 3 to 4 months. As utilities make their purchasing decisions, ARLP is positioned to benefit from its strategically located low-cost operations and strong balance sheet. As evidenced by our performance, ARLP has taken the difficult steps necessary to efficiently and effectively overcome significant challenges. I remain confident that our recent actions to produce fewer tons and strategically adjust production levels to more closely match our contracted coal sales positions have established a reasonable baseline for operations in light of current market conditions. These actions have ARLP well positioned to respond quickly when the market improves. I am also confident that our decision to adjust distributions for ARLP and AHGP has provided our unit holders a distribution level that is both sustainable and supportive of growth over the long-term. I’ll now turn the call back over to Brian for a review of our financial results. Brian?

Thanks Joe. As Joe just mentioned, the Alliance partnerships delivered solid results for the 2016 quarter, posting significant sequential increases to coal sales volumes, revenues, net income, and EBITDA. Taking a closer look at the details, ARLP sold approximately 8 million tons of coal, an increase of 508,000 tons over the sequential quarter driving coal sales revenues higher by $21.2 million and total revenues up by 6.4% or $139.2 million. Expense reduction initiatives at our mines and the shift to production to ARLP's lowest cost operations continued to benefit our performance in the 2016 quarter as segment adjusted EBITDA expenses fell 8.9% or $30.93 per ton compared to the sequential quarter. Increased revenues and lower costs combined to lead net income higher by 74.8% at $82.7 million, while EBITDA rose 24.9% to $169.6 million, both compared to the sequential quarter. As Joe mentioned earlier, ARLP's quarter-over-quarter and year-to-date comparative results for coal sales volumes were negatively impacted by our strategic decision to adjust production volumes in response to weak market conditions. These lower coal sales volumes as well as pricing lead to reduced coal sales revenues, which declined by 25.5% and 24.1% compared to the 2015 quarter and the first half of 2015 respectively. And they were largely responsible for lower net income and EBITDA. Compared to the 2015 quarter and period, net income declined by 12.8% and 35.4% respectively, and EBITDA was lower by 7% and 18.5%, respectively. Although ARLP's net income was lower in the 2016 quarter compared to the 2015 quarter, EPU actually increased by 7.9% as with distribution adjustment we announced earlier this year resulted in reduced allocations of incentive distribution rights to our general partner interest. Our balance sheet remained strong at the end of the 2016 quarter. ARLP completed a new $33.9 million capital lease transaction during the quarter, which contributed to a 5.5% increase in liquidity to $394.5 million compared to the sequential quarter. Leverage also remained very healthy at a conservative 1.34 times net debt to trailing 12 months adjusted EBITDA. With that I will now turn to an update of ARLP's 2016 full year guidance. As outlined in our release this morning, based on higher than expected results to date and our current expectations for the second half of 2016, we are maintaining our previous full-year guidance for coal production in a range of 33.5 million to 34.5 million tons and coal sales volumes in a range of 35 million to 36 million tons. With 2016 anticipated sales volumes essentially fully priced and committed, we are now anticipating our 2016 average coal sales price per ton will be 2.5% to 4.5% lower than 2015 realizations, a slight improvement over our initial 2016 guidance. Reflecting adjusted sales volume and pricing expectations, ARLP currently anticipates fully year 2016 revenues excluding transportation revenues in a range of $1.82 billion to $1.91 billion. On the cost side, ARLP is reducing its estimate for total segment adjusted EBITDA expense per ton for 2016 to be 3.5% to 6% below 2015 levels, which is well below our prior guidance of plus or minus 3% compared to last year. Based on performance through the first half of 2016, an updated volume price, and cost expectations, ARLP is increasing its full year 2016 estimates for net income to a range of $270 million to $310 million and EBITDA to a range of $605 million to $645 million, an improvement of 9.4% and 7.8% respectively over the mid-point of our previous guidance. I’ll now turn to an update on our anticipated capital expenditures and investments for 2016. ARLP's operational efficiency efforts continue to result in lower than expected capital expenditures. As a result, we are again reducing 2016 total estimated capital expenditures to a range of $100 million to $110 million or approximately 23.9% below initial expectations at the mid-point. Activity related to ARLP's acquisition of oil and gas mineral interest is progressing well and we now anticipate completing our current commitment by the end of the year. As a result, we are increasing estimated full year investment for this activity to a range of $80 million to $85 million. Distributable cash flow is expected to be $433.1 million at the mid-point of our EBITDA guidance range at $625 million. We have not adjusted maintenance capital per ton for long term distribution purposes, even though actual year to date maintenance capital is below expectations and total capital expenditures for the 2016 full year have now been lowered to an estimate of $105 million at the mid-point. We continue to anticipate ARLP's distribution coverage will be at least two times during the second half of 2016. This concludes our prepared comments. We appreciate your continued support and interest in both ARLP and AHGP. And now with the operator’s assistance, we will open the call to your questions and then turn the call back to me for closing comments. Thank you.

Thank you. [Operator Instructions] Our first question comes from the line of John Bridges with JPMorgan. Your line is now open.

Hi, good morning, Joe, Brian. Congratulations on the strong results.

Thank you, John.

Just wanted to dig a little bit into the costs you’ve achieved. Just bluntly how sustainable are these costs, what have you done to achieve them and how sustainable are they for the next few years?

We’ve obviously had to focus on our costs given the markets that we are competing in. If you know we’ve been in a transition to move our production from our higher cost mines to our lower cost mines, so that’s been one of the factors and therefore most of the volumes are now that you see are coming from our lower cost mines, our northern Alps Tunnel Ridge mine had a great shipping quarter, that allowed us to run at full capacity there. We feel that the key to having and maintaining our costs will be the ability to move volumes. We do believe that these costs are sustainable for the balance of the year and hopefully running into next year. The one factor that is influencing cost is really our Hamilton mine where we had to pull its production back in the second quarter and third quarter due to sales as we are positioning ourselves for the fourth quarter and the balance of 2017, we are hopeful that we can produce at full capacity there. So that should give us an ability to actually lower our cost in 2017 even further if we are successful in marketing those times and being able to produce Hamilton to full capacity and get those long haul tons at a low cost. They have the potential to be our lowest cost operation and we can market those tons. So we are very proud of the way our operating teams had performed. There has been a lot of movement of people. We’ve adjusted shifts, we’ve moved people from mine to mine, people have made sacrifices personally, but they’ve done it with tremendous attitude of wanting to be the best that they can be, and I’m really proud of what they’ve been able to do. This is as much a people business as anything, and we’ve wouldn’t have had these results if it hadn’t been for co-miners and their attitude to be nimble and be responsive and be the professionals that they are, and normally have they performed on the cost side, they continue to be the safest in the industry, so I’m very proud of and I have confidence that we will be able to sustain these costs for the near-term.

That was very impressive. And I guess with the progress that you are making with the sales, then your expectation to sell all you can generate in Hamilton is improving?

We expect that, yes.

One final bigger picture comment or question, the gas price is sub-$3 now and we are enjoying or suffering under record heat. I just wonder if any comments on that angle and how quickly we could see some sort of respite in terms of reduced supply of gas?

I didn’t pick up your last comment.

Well, just trying to think of when the gas price from your perspective gets – improves from these price levels?

Yeah, well, there are several factors as you are aware. I mean obviously production is one of them, but there are other factors and macros that are going to impact the gas price scenario, really the production scenario. You’ve got the L&G, you got exports to Mexico, you got pipes that may or may not be built and then you’ve got the lending environment. The oil and gas industry is starting to face sort of what the coal industry faced a year or two ago where they are now having to face a bank market that is very focused on performance and liquidity of their customers, and I think that’s going to have an impact on the amount of capital that will flow to the oil and gas producers to be somewhat a buffer bringing back production at a rapid pace. So at the same time, there are a lot of the drilled and completed wells, they are there, so we do believe that any gas price of within $3.50, $3.75 would definitely bring up more supply. So I share the views of many that the gas markets are going to very volatile. They had been historically, and I see no reason why they are not going to continue to be as we look at the supply/demand balance not only of gas and coal, but really just how weather is going to play into it and then the general economy for the U.S. and then you also the world economy. So it’s hard to predict exactly where gas is going to be. I do believe that gas needs to be $3 plus for gas producers to be able to make a reasonable return and to deploy capital. So at $3, we can compete very effectively and be able to get our production back at levels that we may have enjoyed prior to this year.

Well, again, very impressive results and congratulations. Thanks to everyone.

Thanks, John.

Thank you. Our next question comes from the line of Mark Levin with BB&T. Your line is now open.

Hey, guys. Congratulations. That really was a great quarter, particularly on the cost side. I want to shift a little bit to 2017, I realize we are sitting here in July and a lot can happen between now and then, but I guess you guys have contracted or sold about 24 million tons of 2017 , as you look at it today based on where you contracted those 24 million tons, is there any type of preliminary view you would have on where price per ton or revenue per ton might be in 2017, I realize it’s early and a lot can change, but maybe some broad strokes in terms of how to think about price per ton in 2017?

We are – right now, I mean, based on what we are projecting, we would have pricing overall that will impact down anywhere from 12% to 15%, somewhere in that, as it go. A lot depends on how the negotiations go and how fast inventories rebalance during 2016 and what they anticipation is for natural gas prices by the utilities, I mean how much are they going to commit or are they going to have short let [ph] they have been recently. So right now, we are sort of our motive planning for the worst and working for the best essentially. So we are going to do everything we can do to get to a point where we can make reasonable returns on our investment. So I don’t – I think that what we are seeing is that we still have some time to go as far as getting the inventories at both the coal mines as well as the utilities to a level before we could see a price response with that weather and the current natural gas price. We are moving in that direction. So looking strictly to 2017, at our last earnings call, we indicated we built that with the stress test of our plan that we could sustain our distribution at a 1.2 times coverage rate ratio. Since then, our cost are coming in better than what we were projecting at that time and the prices are a little higher than where we were a quarter ago. So right now as we speak that coverage would be in the 1.4 to 1.5 level for 2017.

For 2017, Joe, that sound excellent. And then heading back to your comment a second ago on inventories, obviously the weather I think John just alluded to it now and commodities and the production at least as we’ve seen be the first six months, I assume some of it will come back, but maybe what is your best guess for inventory balance to a point where you guys can really start capturing some pricing leveraging again, is that something that you see as a end of the year event, is that something when you look at the Illinois basin and in northern Alps specifically as a mid-2017 event, how would you sort of handicap market balance in both basis?

I would say from a market perspective overall it’s probably first, second quarter 2017, if you look at individual customers, it could be as early as fourth quarter of this year up to mid-2017.

That sounds good. And then one final question and then I will open it up. I think, Brian, alluded to the fact your leverage was only 1.3 times, obviously, there are a lot of sellers in the coal market today, I would assume they are expectations have come down a fair amount given protracted the downturn has been. When you think about M&A opportunities and you look out over the next 12 months or so, what do you think the probability is here that Alliance does, an accretive or leading major size acquisition over the next 12 months in the coal industry?

Okay. You are breaking up a little bit. What I heard you say is...

The probability is doing a big deal in the coal industry over the next 12 to 18 months.

It's hard to handicap that. I mean we've we are open for opportunities, but those two things have to happen. One, you have to have a favourable lending environment and; two, you have to have sellers that are willing to be reasonable as to the value expectations that they have for their assets. So their willingness on our part to grow through acquisitions, we don't have to, but if there is an opportunity to consolidate and have opportunities where a seller and buyer, in our case the buyer could both look at it on a favourable basis then we are more than happy to participate in that, but it is hard to put it put a percentage on that, I can't do that.

Got it. Thank you guys congratulations on a very good quarter.

I appreciate it, Marc.

Thank you. [Operator Instructions] Our next question comes from the line of Lin Shen with HITE. Your line is now open.

Hi, good morning. Thanks very much for taking my call and congratulations for a good quarter.

Thank you.

I believe that you have between maybe 200 million to 300 million that are going to be matured in early next year, so can you talk about your outlook and also the timing to refinance it?

Yes. Again, you are breaking up a little bit, but I think you are asking about the facilities that are maturing in May 2017 timeframe. We are in discussions with our lead banks and several other primary banks to extend those facilities and we expect that we will have that wrapped up prior to our next earnings call in October.

You also asked about the paydown of the term loan, with the reduction and distribution, we’ve got sufficient cash flow generated by our two times coverage ratio that we are able to do that comfortably as well.

Thanks. I missed that part of the question.

Yeah.

Okay, great. And do you think if you need the high yield market or the debt market can be open for you or you don't see any of that?

Well, I think the high yield market in general has improved from the first part of the year. There is still quite a bit more restructuring that needs to occur within that space. I don't know that it would realistically be open to us at this moment, but I anticipate that as the coal market begin to improve it should come back open for us at some point in time over the next 12 months or so.

Absent an acquisition, we don't really need – we don't need access to debt market, absent a major acquisition.

Okay, great. Thank you very much. I appreciate it.

Thank you. Our next question comes from the line of Michael Goldenberg with Luminus. Your line is now open.

Yes, my question has been answered. Thank you.

Thank you. And I’m showing no further questions in queue at this time. I would now like to...

I’m sorry Andrea.

I would now like to [indiscernible]

It looks like we are wrapped up, so I’ll make some closing comments. ARLP’s financial strength and low cost strategically located operations leave us very well positioned to benefit its coal pricing and demand recovers. Being willing to make the difficult decisions necessary to see us through this challenging market downturn until the market improves, we are confident of our ability to deliver on our goal creating long term value for both ARLP and AHGP unit holders. We appreciate your time this morning, as well as your continued support and interest in both ARLP and AHGP. Our next quarterly earnings release and call are currently scheduled for late October 2016 and we look forward to discussing our third quarter results with you at that time. This concludes our call and thanks to everyone for your participation.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.