Core Natural Resources, Inc. (CNR) Q2 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the CEIX and CCR Second Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mitesh Thakkar. Please go ahead.

Thank you, Danielle, and good morning, everyone. Welcome to CONSOL Energy and CONSOL Coal Resources Second Quarter 2018 Earnings Conference Call. With me today are Jimmy Brock, our Chief Executive Officer; Dave Khani, our Chief Financial Officer; and Jim McCaffrey, our Chief Commercial Officer. We will start with prepared remarks by Jimmy and Dave and then open the floor for the Q&A session. During the prepared remarks, we will refer to certain slides that we have posted on our websites in advance of today's call. I also want to note that CONSOL Energy Inc. issued a press release today announcing an increase in its repurchase authorization. We will refer to this press release during today's call as well. As a reminder, any forward-looking statements or comments we make about future expectations are subject to business risks, which we have laid out for you in our press releases or in previous SEC filings. We do not undertake any obligations of updating any forward-looking statements for future events or otherwise. We will also be discussing certain non-GAAP financial measures, which are defined and reconciled to GAAP financial measures in the press releases and furnished to the SEC on Form 8-K. You can find also additional information on our websites, www.consolenergy.com and www.ccrlp.com. With that, let me turn it over to our CEO, Jimmy Brock.

Thank you, Mitesh, and good morning, everyone. The CONSOL team delivered another solid quarter. Since the separation in the fourth quarter of '17, investors are now able to see the multifaceted cash flow generation capabilities of CONSOL Energy. In the first quarter of '18, we maximized our revenues through our power netback contracts, while in the second quarter of '18, we delivered record volume performance at the Pennsylvania Mining Complex. You will continue to see us differentiate ourselves from the pack due to our well-capitalized mining complex, well-positioned export terminal, best-in-class personnel and our overall strategy. From a CEIX perspective, there have been two major developments for us since the first quarter. First, we reduced our net leverage ratio from 2x to 1.6x, which is now in our comfort zone. Secondly, our board increased our ability to return more capital to our shareholders by increasing CEIX debt and equity repurchase authorization from $50 million to $100 million. From a CCR perspective, we had a double-digit distribution yield to unitholders, which is covered 1.6x based on our second quarter '18 distributable cash flow. We also reduced leverage on CCR's balance sheet, which enhances our ability to continue to pay at this high level of distributions. As I indicated last quarter, we are starting to see some initial benefits from efficiency improvement projects that we initiated at the Pennsylvania Mining Complex. Now let me review our operational performance for the second quarter of '18. Second quarter of '18 was a memorable quarter from an operations standpoint for a number of reasons. Some of the key highlights during the quarter include. One, we reduced the number of reportable employee incidents by 50% compared to the first quarter of '18; second, we achieved a record production volume at the Pennsylvania mining, partially driven by the highest productivity level at the complex since the first quarter of 2004; third, cash cost of sales per ton at Pennsylvania Mining Complex came in at approximately $27 per ton, improved 7% compared to the year ago quarter. Let me now provide you with some of the details behind those highlights. The Pennsylvania Mining Complex achieved strong second quarter '18 production of 7.7 million tons or an annualized run rate of more than 28.5 million tons. Production increased approximately 13% compared to the year ago quarter as we benefited from solid production at Bailey and the Harvey mines. Furthermore, the Enlow Fork mine also showed improvement in the quarter compared to the sequential as well as the year ago quarters. Enlow Fork finished off the F27 panel, which was geologically very challenging, and has now transitioned to F28, which we believe will provide some operational relief as we improve our ability to manage these conditions. Our team continues to look forward to mid-2019 when the F side wall at Enlow Fork mine will move to a different district, which we believe will provide much better mining conditions. The quarter also benefited from favorable longwall moves and well-synchronized logistics. For its share of PAMC, CCR produced 1.9 million tons of coal during the second quarter of '18, which has improved from the 1.7 million tons produced in the second quarter of '17. For second quarter '18, the productivity at the Pennsylvania Mining Complex, measured as tons per employee-hour, improved by 13% compared to the previous quarter and 14% compared to the year ago quarter. On the cost front, our average cash cost of coal sold per ton was $26.99 compared to $29.08 in the year ago quarter. This improvement was largely driven by improved productivity; by a reduction in lease expenditures, which we discussed in the past; and by the distribution of our fixed cost over a high level of production, which was partially offset by some inflationary. With that, let me now provide an overview of the coal markets and an update on our sales performance and marketing efforts. Second quarter of '18 was a strong quarter on the sales and marketing side as well. Some of the key highlights during the quarter include: we achieved a sales volume of 7.8 million tons, an approximate 15% improvement compared to the year ago quarter and the highest-ever quarterly sales volume in the history of the Pennsylvania Mining Complex; second, average revenue per ton improved approximately 6% compared to the year ago quarter; third, we reentered the domestic metallurgical coal market. In the first quarter of 2018, our coal revenues increased due to higher domestic coal prices, driven by our netback contracts, which benefited us due to higher power prices during the winter. In the second quarter of '18, our average revenue per ton was impaired 11% sequentially but improved approximately 6% versus the year ago quarter. The sequential impairment was a result of more normal revenues per ton on our netback contracts during the quarter versus the strong pricing experienced during January's bomb cyclone. Overall, our netback pricing has been very favorable throughout the first half of '18 with June being the only exception. July netback power pricing has returned to the favorable trend. Our export prices were up 7% in the first half of '18 versus the first half of '17. And we expect pricing to improve further during the second half as our previously announced export marketing agreement fully engages. However, the main story for second quarter of '18 was the approximate 15% year-on-year improvement in sales volume. While Henry Hub natural gas prices averaged 7.5% lower in the second quarter of '18 at $2.85 per million BTU compared to $3.08 per million BTU in the second quarter of '17, we were able to sell more coal and improve our average revenue per ton in the domestic market as well as the export market. These improvements not only highlight our operational strengths but also are a testament to the strong demand in the domestic and international coal markets we serve. Let me first talk about the domestic market dynamics. First, coal inventories continue to decline in the U.S., as noted in our press release. Total coal inventories at domestic power plants as of May 31st were 21% lower than year ago levels. I will also note that typically, you see inventory levels build in May from April levels. However, this year, we saw the inventory levels decline. Bituminous coal inventories were lower by 24% year-on-year, and several of our key customer Northern App rail-served power plants continue to report around 20 days of inventory. This bodes well as we head into the annual RFP season. We are seeing solid demand forming as domestic utilities need to rebuild lower inventories that have resulted from a return to normal summer and winter weather and the extremely strong demand in the international marketplace. Second, the domestic supply picture remains challenging for inventory restocking. Coal producers continue to see an increase in export demand and are diverting supply away from the domestic generators. According to the Doyle Trading Consultants, for first half of 2018, U.S. exports from the East and Gulf Coast totaled approximately 48 million tons or up 30% compared to the year ago period. First half steam coal exports grew approximately 23 million tons or up a very robust 65% year-on-year. Furthermore, we're also seeing several coal producers, particularly in the PRB, curtailing production instead of placing less desirable priced business into the domestic markets. In Northern App, logistics, poor capacity, geological conditions and other operating issues have curtailed some production. Given this backdrop in the domestic market, we had a very successful quarter from a new market development perspective. First, we were able to secure a term contract with a Midwestern utility, which fits with our overall market strategy of supplying coal to efficient domestic power plants that operate at high capacity factors. We were also able to secure a commitment from a domestic steelmaker that plans to include Bailey coal in its metallurgical coal blend. This is an important development since it marks our reentry into the domestic metallurgical coal market and expands the number of addressable markets for our products. We expect to increase our penetration further in the domestic metallurgical coal markets as the average sulfur content of our product declines over the next several years. International coal markets remain robust. API 2 coal prices averaged approximately 17% higher in second quarter of '18 compared to the second quarter of '17. Based on current prompt and forward API 2 prices, the netbacks to our mines remain around the $50 per ton level. The current forward curve for typical high-BTU domestic Northern App thermal coal is in the mid- to high 40s. We expect that domestic market pricing will remain somewhat challenged relative to the export pricing. Similar dynamics exist for other basins such as Central Appalachia and the Illinois Basin. As a result, we continue to develop new export markets for our coals. During the quarter, an exporter of our coal was successful in remarketing our coal to new end users in China, Europe and Africa. The coal was marketed under the CONSOL brand, and we expect this goodwill to help us continue to expand our market geography. Looking forward to the remainder of 2018 and beyond, we are in very good shape. Our new contract with Xcoal began in the second quarter of '18. We are 74% and 32% contracted for 2019 and 2020, respectively, assuming a 27 million ton annual sales volume for the Pennsylvania Mining Complex. With low coal inventories domestically and strong export markets, we are very comfortable with our prospects to contract and optimize our coal position for 2019 and beyond. With that, I will now turn the call over to David to provide the financial update.

Thank you, Jimmy. This morning, I will provide a review of the quarter and update to our 2018 guidance. Before I do so, let me provide some perspectives on the current macro supply and demand outlook and tie it to the current coal group valuation. Global demand is improving gradually, while global supply remains challenged to stay flat. We are seeing supplies stretched not only in the U.S., as Jimmy has noted, but also from major seaborne coal exporters such as Colombia and Australia. The 2019 forward curve for the API 2 prices remain volatile and thinly traded but has improved 18% during the second quarter of 2018. With this backdrop, coal valuations are close to historic lows. Let me draw your attention to Slide 8 that we have uploaded this morning to the Investors section of our website. In early 2017, the coal group was trading at 5.7 times using consensus 2018 EBITDA at the time. Now about a year later, the coal group is trading at 4.4 times EV-to-2018 EBITDA as forecasts for EBITDA have outperformed expectations and management teams have focused on disciplined use of its free cash flow. Average 2018 consensus EBITDA expectations for the peer group have improved by approximately 32% in the last four quarters. This seems to be largely driven by the higher-than-expected and more sustainable pricing that we've seen for seaborne thermal and coking coals. It is very important to understand this dynamic because the market underestimated the sustainability in price and, ultimately, the underlying coal equity value. A similar dynamic is in play as you look at 2019. Based on consensus estimates for 2019 EBITDA, the coal group EV multiple increases by nearly 25% to 5.4 times as a function of low coal price expectations and limited use of the company's free cash flow generation. The sharper decline in 2019 consensus coal price expectations do not match up with the flat forward coking coal curve and the slightly backward API 2 outlook. While there are worries about trade impact, we believe the end result will be positive for the coal demand. On the supply side, the multiyear lack of investment in new mines and equipment, along with the depletion curve, will put downward pressure on coal supply and coal quality. The significant arbitrage in BTU values between coal and other energy products also underpins the sustainability in prices. With the industry's balance sheet in strong shape, with fundamentals lined up to be solid for multi-years and with free cash flow generation in all parts of the cycle, the space appears to be ready for a re-rating. Historically, the non-cap coal names have traded at an average EV-to-EBITDA of over 7x. A similar valuation phenomenon occurred in the year 2000 when multiples and coal price expectations expanded into 2005, driving significant outperformance for the group. Now let me move over to our financial performance where I'm very excited to recap the quarter and give an update on our guidance. We will review CEIX first and then CCR. CEIX reported a strong financial quarter with net income of $53 million, adjusted EBITDA of $136 million and organic free cash flow net to CEIX shareholders of $123 million. This compares to $52 million, $96 million and $36 million, respectively, in the year ago quarter. On a per-ton basis, our coal margins improved $4.68 to $20.35 compared to the year ago levels as prices rose $2.59 to $47.34 while cash costs decreased $2.09 to $26.99. With a high percentage of fixed costs, rising prices mostly fall to the bottom line, and there's an overall cost benefit due to higher volumes. During the quarter, we generated $162 million of cash flow from operations and spent $34 million in capital expenditures. I will highlight, though, that during the quarter, our cash flow from operations benefited from a $55 million inflow from changes in working capital while the first quarter had actually negative working capital. So as you can see, this can swing quarter-to-quarter. Since implementing our disciplined capital allocation process, we've repurchased $49 million of debt and 0.3% of our shares, driving down our cost of capital. We've also begun to invest in our high rate of return [Indiscernible] making projects, which are beginning to bear fruit and should only accelerate in -- the benefits into 2019. With the deleveraging from 2.4x at the end of the 2017 to 1.6x at 2Q '18, we now have the flexibility to improve our return on capital employed to increasing our buybacks and investments. We will remain very focused and keep on -- return focused, and our goal is to keep our balance sheet in pristine shape at or below 2x net leverage. This morning, CCR also reported a strong financial quarter with net income of $19 million, adjusted EBITDA of $34 million and distributable cash flow of $22 million. This compares to $11 million, $25 million and $12 million, respectively, in the year ago quarter. The most important metric for CCR is the distribution coverage. We generated a distribution coverage of 1.6x during the quarter compared to 1x in the year ago period. Now during the quarter, CCR generated $49 million in net cash flow from operating activities, which included a $17 million benefit from the reduction in working capital. After accounting for $7 million in capital expenditures and $14 million in distribution payments, we were able to pay down approximately $27 million in debt. CCR's net leverage ratio improved to 1.5x. We believe the strongest distribution coverage and low leverage on our balance sheet should provide added comfort to our unitholders regarding the loan-term sustainability of our current distribution. Now let me provide you with an update on our 2018 guidance. Our guidance philosophy has always been to measure the risk at the beginning of the year and being able to prove upon our guidance through our strong execution as the year progresses. Our teams have been very diligent in understanding the upsides and downsides in our business, and we are always working on ways to improve the forecasts, creating more upside while decreasing the downside risks. As a result, this is the second successive quarter in the row that we are increasing our adjusted EBITDA guidance for the full year. For PAMC complex, we are increasing our 2018 sales volume guidance. The market appears set to absorb all we can produce with a significant restocking needed as inventories are well below normal. We raised our PAMC gross sales guidance by 200,000 tons and margins by $0.55 per ton at the midpoint. We increased price expectations by $0.30 and decreased cash costs by $0.25 per ton. Based on this new guidance, we raised our adjusted EBITDA forecasts for CCR and CEIX by $5 million and $45 million, respectively. The CEIX adjusted EBITDA guidance improvement also reflects higher-than-previously-expected royalty income and higher other miscellaneous income associated with property owned by CEIX outside the Pennsylvania Mining Complex. Now let me provide you some color on the second quarter half -- the second half expectations. First, the PA Mining Complex is expected to have three longwall moves during the third quarter. Typically, we have six to eight longwall moves during the year or average 1.5 to two per quarter. Due to the unusually high number of longwall moves, we expect the third quarter production volume to be below the second quarter but then rebound into the fourth quarter. Based on our expectations for full year CapEx that we have provided, we also expect third quarter CapEx to be elevated versus the second quarter, which could impact our free cash flow. Third, from a CEIX perspective, we have increased our cash on the balance sheet by $93 million in the second quarter to $285 million. Year-to-date, we have generated approximately $211 million in organic free cash flow net to CEIX shareholders or approximately 18% of current market cap. This will allow us to continue to opportunistically pay down our debt and buy back our stock as market conditions warrant. Fourth, from a CCR perspective, the third quarter production capital changes could temporarily drive a sub one time distribution coverage for the quarter. However, as we stated in the past, we expect our distribution decision to be based on our expected annual coverage, among other factors, as such. We do not see this lower production as a risk to our ability to pay quarterly distributions. With that, let me turn this back to Jimmy to make some more final comments.

Thank you, David. Before we move on to the Q&A session, let me take this opportunity to provide you an update on some key priorities we highlighted on our last earnings call. As a reminder, our key priorities for CEIX were, one, to derisk the balance sheet. As you've already heard, we continued to take our leverage ratio down during the quarter as we repurchased some debt. I will also highlight that while the headline of 1.6 times leverage speaks to this achievement, it is based on the more conservative bank method that is used by lenders. Our adjusted leverage is now down to 1.3 times. Reconciliations of both of these metrics are available in the slide deck we posted this morning. Second, to grow opportunistically. I am very pleased to announce that we have started the permitting process for the Itmann project. The Itmann project is a low-vol metallurgical coal projected situated in West Virginia. We expect the coal quality to be very attractive to domestic as well as international steel customers. It is too early to provide you any color on the amount of CapEx, timing and production that might result from this project, so we will not be able to answer those questions for you today. Nonetheless, we are very excited about this potential opportunity that will allow us to expand beyond the Pennsylvania Mining Complex and take advantage of some of our vast portfolio of undeveloped reserves. Third, to increase shareholder returns. With our leverage ratio now below two times, we have better ability to pursue shareholder-friendly actions. Accordingly, this morning, our Board of Directors increased our authorization to pursue such opportunities to $100 million from $50 million previously. As of the end of the second quarter, the availability under this authorization stands at approximately $74 million and falls within the limits of the covenants in our credit agreement. The new authorization also includes an additional option for CEIX to repurchase and hold CCR units. This is a win-win for both companies. From a CCR standpoint, it demonstrates the confidence that the sponsor has in CCR and the attractive value its units provide. From a CEIX standpoint, the shareholders can benefit from the arbitrage created among multiple options, including CEIX stock, CCR units and CEIX second-lien bonds. Let me assure you that we do not believe that investing in the Itmann project will limit our ability to pursue options under our recently increased repurchase authorization. In summary, I am very excited about what the future has in store for us. Operationally, we are in very good shape, and our employees continue to work on cost reductions through technology and innovation, which is driving our results. Our marketing team continues to find new customers and new avenues for us to grow. Financially, we have reduced a lot of risk from our balance sheet by delevering and increasing our liquidity. In the coming quarters, our focus will be on growing the business and taking advantage of arbitrage opportunities among the various securities we have in the capital markets to create value for our shareholders. And with that, I'll hand the call back over to Mitesh for further instructions.

Thank you very much, Jimmy. We will now move to the Q&A session of the call. Danielle, can you please provide the instruction to our callers?

We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Jeremy Sussman of Clarksons. Please go ahead.

I guess a really solid quarter, and nice to hear about the domestic steel contract that you guys signed. I guess can you talk a little bit more about kind of how this came about? Is this for 2019? What type of volume do you think we could ultimately see cross over into the met market next year? It sounds like a pretty exciting opportunity.

Well, let's divide it. It's -- this is Jim, Jeremy. Let's divide it into two pieces. First of all, going to the export met market, we're on pace to do approximately 2 million tons this year, and we have, next year, the same amount put to bed in the export met market. Now in the domestic met market, we participated in this market back in 2012 and 2013 with barely Bailey crossover tons. But during the years '14, '15 and '16 primarily and a little a bit into '17, our sulfur levels increased based on the geology of the coal mines and just the position geographically of our longwalls. We're now through that period, and looking for '19 and forward for the next five to six years, our average sulfur-to-property is going to be somewhere between 2.3% and 2.5%, but we'll have the ability to segregate out some coals from Harvey and from Enlow Fork that will actually be below 2% sulfur. This will allow us to participate in this market more heavily again in the future. The initial sale is not a huge number. It's all going to be delivered in the second half of '18. We anticipate that we'll participate in '19 going forward because of the lower sulfur. I would say the opportunity is not just with one company but with a couple or three, and the potential is 300,000 to 500,000 tons a year.

Appreciate the color, Jim. That's very helpful. And maybe just as a follow-up, switching gears a bit. Nice to see the repurchase authorization doubled this quarter. How should we kind of think about the three buckets between CCR, CEIX equity and the senior notes in terms of kind of how you think about which offers the most attractive returns for you guys?

Yes, I'll take the first part of it, Jeremy, and then I'll turn it over to Dave to add some color behind it. But for us, it's all going to be all about rate of return. So we've said many times that every capital dollar we spend, it'll be based on rate of return and whichever project generates that highest rate of return. That's where we'll take the capital money to. Now, however, as you know, it does give us a lot of options now. We're happy to have that, and we'll continue down that path. And Dave, do you want to add some color there?

Yes. So the team here has been spending a lot of time trying to build that opportunity set to think about where we put our dollars and make sure that we can drive the highest rate of return. So we added CCR to the bucket. We also have our efficiency projects, and, obviously, we're looking at Itmann. We haven't committed to Itmann, but we're looking at Itmann, which could be a very high rate of return project. So that's our goal. And so we're going to be very opportunistic. Whatever gives us the best rate of return at the moment in time. And we know we have internal views on what each thing is worth and what the rates of returns are. And obviously, as volatility plays into the role of what CEIX is trading at, what CCR is trading at, our second lien is trading at, there will be moments in time where one's better than the other and that all has been predicated now because we've actually delevered our balance sheet to a point where our first goal was to pay down debt irregardless of rate of return. And now we have that flexibility to be more aggressive.

Well, it sounds like it's nice to have all the options on the table.

Yes, it is.

The next question comes from Mark Levin of Seaport Global. Please go ahead.

You kind of answered my question, David, before, but I'll throw it out there anyway. So through the first half of the year, you guys are roughly two third through the midpoint of your EBITDA guidance. It sounds to me like, obviously, you've got three longwall moves in Q3, and the production likely won't be nearly as good in Q3 as it was in Q2. But is there still yet another chance that -- I mean, because you've raised guidance now two times now in the last two quarters if you execute well, as well as you've been executing previously, that there could be more upward pressure on that number as the year progresses?

Well, there certainly could be. Of course, we've been very, very careful on how we got it. When we do is, we take those actual quarters in and look at what our forecast is as we go out, we guide, as you know, on an annualized basis. So there is a lot of volatility quarter-to-quarter. Now, obviously, the third quarter, having three longwall moves in it, will be as Dave said earlier in his remarks, it'll be lower in production, but there's other things we can offset. And as long as we continue to gain efficiencies and drive towards that cost efficiency and higher volumes of productivity, we could possibly raise the guidance again.

Yes. Again, if I point to the kind of the -- our methodology, we go through the upside and downsides every quarter before we spend -- before we set the guidance. And so if we didn't feel like there was upside, and that's why we provide ranges, and we hope you use the midpoint of the range usually, but we -- as we execute the quarter, we hopefully have the ability to raise guidance, right, and that's the goal. But we're also prepared for the downsides because, as you know, this business creates downsides, and we have to get through that as well. So we try to set this very methodically and set the guidance where we think we can achieve that midpoint. But obviously, if we execute our game plan at the best side of the equation, there's always upside.

No, that makes sense. So two market questions. Let me start on the export side. Maybe you guys can give some color on what you're seeing in Turkey. I know there's a lot going on there. Last quarter, you talked about it maybe being a potentially 2 million- to 4 million-ton opportunity for NAPP coal. Obviously, they're in the middle of all of the trade-related noise. Maybe some comments or some updated thoughts on Turkey and then also what you're seeing from India these days.

Okay. Well, let's talk about Turkey first. The geopolitical situation in Turkey has not -- has certainly not improved since our last earnings call. We still think that the potential to send higher sulfur to Turkey will be there in the not-too-distant future. We still think that the initial opportunity is 2 million to 4 million tons. But on June 21, Turkey put a 10% tariff on U.S. coal as part of a response to the current trade war situation and I think the geopolitical tensions that we're seeing between the two countries. So right now, I would say that, that -- I'm not as optimistic about that as I was at the last earnings call, but I still think that they're going to change the sulfur inputs, Mark. And when they do that that'll create opportunity for our higher-sulfur coals. And ultimately, we'll be able to take advantage of that. But it's difficult to say how soon that'll be.

How about India, Jim?

In India, we have about 4.4 million tons of export in the first half of the year. So that's 31% of our sales. And 69% of that export went to India. So India has been very strong for us. Demand continues to be there. I know 69% probably sounds a little imbalanced, but it's kind of like when asked really all of a sudden, why do you rub backs, the market is in India. And if you look at U.S. exports in India for the first half of the year, they're at 7 million tons. I would expect that we'll see 12 million to 15 million tons of exports go to India by the end of the year, the vast majority of that being Northern App with a little of our Bs spur over that.

And then last question, guys, the domestic comments that you guys were making. And I just thought it was interesting, the comments about natural gas prices and how much they have declined, yet demand seems to be pretty resilient. Maybe you can talk a little bit about what you're seeing in the domestic market. I think we've all been trained to believe that if natural gas prices are weak or weakening, that demand goes along with it. But it sounds like to me that you guys are seeing something maybe a little different this time.

Well, first of all, you heard us talk about the increase in the export numbers. And as I just said, 7 million tons has gone to India in the first half of the year. So there's a lot of tons going offshore, and that's creating some demand here at home. There are several customers. that's creating some demand here at home. There are several customers. We've been talking about inventory now for the last two or three earnings calls. But most of our major customers have found that either they have been short inventory. Some -- has got -- have gotten down below 10 days. They're now built back up to between 10 and 20 days. But most of our major customers are around 20 days. So all of them are strongly demanding their coal. All of them have some need and desire to restock. We anticipated that pricing will be fairly decent for the first half of '19 and the second half of '19 as well. I think there will be some opportunities to do some term business. There are some RFPs are out there that are very encouraging. And we're working on a number of things right now that I can't talk about, but we're optimistic as far as the domestic situation goes.

Yes. And I think just from a little bit of a gas macro standpoint, we're watching -- some of the same things that have been pushed on to the coal side have really kind of followed the same thing on the gas side. And that is, the investors are kind of pushing for more disciplined use of their operating cash flow, and so more repatriation of cash. At the end of the day, commodity stocks work really well, and commodity was up and not down. And so we're starting to see a lot of pressure, and we're seeing more and more of the companies moving to a free cash flow and stock buyback mode and kind of throwing back the capital and the growth a little bit. And we're seeing companies being punished today for outspending cash flow. And so it's a signal, as stock prices get pulled down, that they would like the repatriation of cash. And so we're watching the production growth start to get throttled back a little bit in Appalachia. We still haven't seen it happen in the Permian yet, although the pipes are probably the biggest part that's going to throttle it back. And we also see the same kind of arbitrage get -- LNG energy prices are very strong overseas, and there's more value to export the gas than to keep it in the U.S. And as a result, we're seeing -- we have low inventory levels on gas just like we have on coal. We are -- we're also seeing injection rates running 1.5 Bs a day less than the five year average injection, and I would tell you that the five year levels of storage are actually very inadequate for where gas demand and gas supply is today. So there's a lot of same issues that you see on coal that you see on gas here. And at the end of the day, investors want rate of return. And right now, they're not seeing the rate of return. So it's all good. I think at the end of the day, it's going to move the gas picture to a place where prices have to move up over time at some point. It may not be today. It may be a year or two down the road, but the forces are in place.

The next question comes from Lucas Pipes of B. Riley FBR. Please go ahead.

Ted Beachley here for Lucas Pipes. So looking at second quarter operations, we were impressed with the cost performance. My first question is, going forward, what's the potential for further cost improvements, especially now that Enlow Fork has transitioned out of the F27 panel? Also, how are you guys thinking about inflation hitting cost going forward?

Well, I think when you look at the costs, the operations did provide a very solid cost number. And we had a high volume that makes that cost -- it offsets some of the higher costs a little bit. I think looking forward, some of these efficiency projects that we've done, they're going to continue to let us improve our cost inefficiencies as we go. And we look at inflations -- we have -- we think it's going to be 0 to 5% for us, somewhere in that range, on inflation because we have a lot of tools that we can use to rebalance that. You can take volume and offset some of those higher cost numbers. And I think our employees, I got to give credit to them at the coal mines. They are really focused on looking at innovative things and ways to reduce cost even further and become more efficient. So I think we'll continue to stay even with inflation at 0 to 5% range, and the team will do very well at becoming very efficient.

And as - if you look at our forecast, we've baked that into our forecast. And I think the only other thing I would add is, our employees are actually incented off of unit costs. And so it -- it's -- it aligns the way we want them to be aligned and focusing on taking unit costs down.

The next question comes from Michael Dudas of Vertical Research. Please go ahead.

A question on your -- the term contract with the Midwest utility that you indicated in your comments. Is that -- how far is that relative to the complex? Is it farthest-out customer in that market? And were getting -- gaining the share there? Is it a brand-new customer? And on top of that, how you feel your competitors in Northern App who are less well capitalized can be able to meet some of the production needs if we continue to see this export market? And I think Dave has already [indiscernible] for -- positive gas comments will come through.

Well, it's a customer that we had in the past, we lost and we have back. The plant they have runs at a very high capacity factor. It fits perfectly into our sales strategy, our market strategy of having high capacity, must-run plants. And so we're happy to have them back in the portfolio, and we expect to be able to keep them into the future. I don't know if that answers your question, Mike, but that's that.

No, that's fair. Oh, how far -- how long was the longwall contract?

It's through '19.

And on competitive aspects of some of your competitors meeting their needs?

I think if you look at some of our competitors around, you've seen -- and I'm sure there's been issues. Logistics is one of the things that we heard. Some geological issues, as we talked about earlier. But I think it's really hard for us to come back to the supply side and produce a lot of volumes quickly because of the lack of capital spending in the previous years where everyone was trying to survive. So you're not going to get high productivity levels coming back even though some operations are run better than others. But I think the supply is pretty much in balance in Northern App.

And my follow-up is related to Itmann, maybe Dave. You talked about rates of returns and allocation. Generally, I'm assuming this is a 12- to 18-month process for permitting and prefeasibility before you make a decision. And how comfortable -- early indications on returns relative to your current risk-adjusted cost of capital?

Well, I think when you look at the Itmann project, the permitting, you hit on it, it's 12 to 18 months. It could be accelerated depending on how well water samples and other things come in. And then when you look at just for surety of the project, we're doing some exploration holes now. We need to know what the quality of the coal is as well as the same high -- as well as the gas absorption. So there's a lot of moving parts there. That's why we can't give a lot of color on it right now. But we think the price of our coal will be very good. It's a very unique product. There's not a lot of it. It's a low-vol sulfur metallurgical product, and we think it'll go very well in the marketplace.

Yes. And as we've said before, we're not going to spend a lot of capital on something that doesn't have a contract duration on it, so it will not be a very high capital number. And we've looked at other -- and we've looked at ways at like JVs and things like that where we always look at ways to mitigate the risk. And so we're in permitting mode and sort of derisking mode. And at some point, we'll decide whether this is a project we're going to sanction and fund.

We anticipate that this going to be a very marketable premium, low-vol product, but we're just firming up our information right now. So I would say stay tuned to the next earnings call. We'll have some more detail, I think, on that by then.

Yes, we will for sure. And keep in mind this is not a total greenfield project. I mean, we've been in these reserves before. We mined them many years ago. We'll go at them differently this time. But it's not -- to today's point, it won't be an extremely high-capital project.

The next question comes from George Wang of Citigroup. Please go ahead.

Yes, just in terms of next growth initiatives for CCR, either FX transactions or even drop-downs in the long run, do you guys have any thoughts on kind of timing and the constraint for future drop-downs?

Well, continue to evaluate CCR, as always. Our strategy hasn't changed there. We look at all opportunities for CCR to come in. And again, it's our lone rated capital, a return of capital of what we spend. So currently, no, we haven't done anything with CCR. It is still yielding a very high yield to those unitholders. But we evaluate any opportunity to CCR as well as CEIX, and we'll continue to do that moving forward.

And also, do you guys see foresee any possible asset transactions? Just kind of are you guys looking at any specific assets?

To drop in into CCR? Is that what your question is?

Yes, it's more just the third-party assets from elsewhere. I don't know if you guys are looking at any accretive transaction.

Yes, George we have a business development group, and this business development group spent a lot of time initially looking at our own assets. But we do spend time now on third-party assets. There's private equity out there looking at things to monetize things. There's a whole bunch of other assets out there. So we compare against our own assets and our opportunity set, and that gives us increased confidence to know what the marketplace is and what the values are and what's the - which right direction do we go. And so yes, we do it spend a lot of time on that.

Okay. Now...

And George, as...

Yes?

And that's exactly how the Itmann project was developed, is that business development team. We continue to have people contact us and call. And we look at all of those. We take all of them very seriously. And we just want to make sure that we do all the due diligence so when we decide to pull the trigger, we have all the information we need and it will be a great rate of return project for us.

And a follow-up just here. I mean, looking at the unit price and the yield, it's yielding $0.12 while the recovery is still pretty adequate at 1.6x. So do you guys have any thoughts on the disconnect of the high-yield double digit versus still ample coverage over 1.5x? And do you see any upcoming catalysts for the yield to re-rate lower?

Well, it's the same issue that we have at CEIX with the valuation. It's -- the valuation is anticipating either unsustainable coal prices or not using the free cash flow to drive value. So I think it's the same thing that it's CEIX -- I think its commodity stocks in general and coal stocks on coal pricing. So for us, the way we're going to take advantage of it effectively is -- that's why we want CEIX to be able to buy CCR stock units and take it in -- take some of those units back in because we see that as an opportunity to add some value. And maybe that will help take the unit price up.

Yes, that's definitely good initiative. And in terms of your distribution policy, are you guys still speaking to sort of annual assessment? Or do you think given the high yields and also ample coverage, that it may possibly raise distribution going forward?

Yes, we'll continue to look at CCR, particularly with the distributions on an annualized rate.

The next question comes from Ajay Lele of Southpaw.

I had just a couple. The first was just on the gas competition side. There are a couple of big pipelines moving through your state. Rover, Atlantic Sunrise is on the -- have plans to be built. And I know that prices have gone up, I guess, a little bit recently. As some of this new production has come online, gas production being sent out of the basin. Is it right to think that coal burn is maybe up temporarily because of price differentials and -- versus coal, versus gas? And sort of what's going on sort of 2 or 3 years from now? Because if production is kind of up and more of these pipelines are getting filled, does it -- do you have a view on kind of load factors from some of your target plants going out 2 or 3 years? I'm just sort of struggling with why there's no forward market developing or why your prices are expected to sort of remain despite the new gas production coming on.

Well, first of all, we can look back at the first quarter of 2018 and tell you that in the PJM, total generation increased by 5%. And we expect some increase in the second quarter as well over the Q-on-Q from '17, but we don't have that data yet. Now in the first quarter that 5% increase in generation, coal was relatively flat and gas did pick up some generation, and nuclear was also pretty steady. As we look forward at the marketplace, we, again, are very focused on a certain subset of customers. It doesn't mean that that's the only place we'll sell our coal to, but we're certainly focused on a subset of customers that we believe in any environment will continue to run their coal plants. So I think that that's the best answer I can give you to your complicated question. Dave, do you want to add something to that?

Yes, I mean, I think you see -- actually, within the PJM, you saw this gas-fired generation build that's pretty much stopping because coal prices have not been very supportive of us spending incremental capital to build gas-fired generation. So I'd just say that not a lot of companies in the energy space are actually running a rate of return, and that's going to work its way through the system. And I think we're going to wake up and realize that gas prices need to be higher, coal prices probably need to be sustainable and power prices need to be sustainable. Otherwise, the investment process is going to slow down dramatically, and that'll cause an improvement. So to Jim's point, we're very tactical on where we sell our coal to, and we are also very cognizant of what's coming online, what's getting delayed. And that allows us to think about how we maneuver through that -- the volatility and -- that we deal with. Because if you think about it, coal burn was 1 billion tons, and now it's down into the 700 million ton-ish range. So we've been living through a 30% decline in coal burn. And yet, if you look at how we've been selling our coal and what our market share has done on a relative basis, we've actually outperformed.

On top of that, very basically but in 2018, we have a return of -- we've seen relatively normal weather. We had one real cold spell in the winter, one real warm spell in the summer, and those reflected in our netback power pricing on our netback power contracts fairly well. And for the most part in the other months, we also had pretty respectable performance on those netback power contracts. So we anticipate that that's going to continue. And then couple that with the fact that we see an increased economic growth in the country, 4.1% GDP in the second quarter, and all that, we believe, will lend itself to more energy uses -- usage, and we think that'll benefit us as well.

The next question comes from Lin Shen of Hite. Please go ahead.

I just want to reconcile a question on the average revenue per ton for your new guidance. When I look at your first quarter, like the average revenue per ton is $53 and second quarter, $43.30. Then your 2018 guidance is around $48 something. So -- and also, on the other hand, I saw the thermal coal index is better for third quarter now versus last quarter. So how should we think about your guidance? Is it like the conservative side? Or what kind of assumption I should think about?

I think in terms of the pricing, I think that, as Dave said earlier, we have a very strict methodology to forecast our forward pricing. We follow that very closely. And I think the numbers that you're seeing in our guidance are reflective of the fact that we had a very strong first quarter in terms of netback pricing. We're hopeful that we'll have a strong second half and a strong fourth quarter as well, but our methodology doesn't reflect that it'll be as strong as the first half. So I think that that's the primary reason you see our guidance is a little bit less than what we had in the first quarter.

And I believe that if I remember it correctly, you will have 5% to 10% coal to be crossed to -- crossed over to met coal but not meaningful for first half this year due to the legacy contracts. So should I think about more crossovers to met coal second half this year?

In the second half -- we -- we'll do 500,000 -- we did approximately 500,000 tons per quarter in the first half, and we'll do the same thing in the second half. So we'll be 2 million tons. We've said in the past its 5% to 10% higher than our other product. And you're correct, we had some legacy pricing in the first half with export thermal, and we also had legacy pricing in the first have with export met. We have a fairly solid pricing on our export thermal going forward. It's -- it has a 5 handle on it. And the met coal is 5% to 10% above that also with a 5 handle on it, as we have said in the past.

This concludes our question-and-answer session. I would like -- now I'd like to turn the conference back over to Mr. Thakkar for closing remarks.

Thank you, Danielle. We appreciate everyone's time this morning, and thank you for your interest in and support of CEIX and CCR. Hopefully, we were able to answer most of your questions today. We look forward to our next quarterly earnings call. Thank you, everybody.

This concludes the conference. Thank you for attending today's presentation. You may now disconnect.