Hallador Energy Company (HNRG) Q3 2019 Earnings Report, Transcript and Summary

Good day, and welcome to Hallador Energy's Third Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Becky Palumbo, Vice President of Corporate Affairs. Please go ahead.

Thank you, Eileen. Thank you, everybody for taking the time to join us today to discuss our Third Quarter 2019 Results. As a reminder, this event is being webcast live and you will be able to access a replay of this call on our website. We filed our third quarter Form 10-Q yesterday afternoon and it is now posted on our website. Participating on today's call is Brent Bilsland, our President and CEO; and Larry Martin, our CFO. Larry will begin with a financial overview of the quarter, followed by Brent with comments on operations. After they complete their opening remarks, we will open the line up for Q&A. Today, our remarks will include forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially. For example, our estimates of mining costs, future coal sales and regulations relating to the Clean Air Act and other environmental initiatives. We do not undertake to update our forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law. And with that, I turn the call over to Larry.

Thank you, Becky, and good afternoon, everyone. First, I would like to explain a couple of definitions. We define free cash flow as net income, plus deferred income taxes, depreciation and amortization, reclamation accretion, stock compensation, less maintenance CapEx and the effects of our equity method investments. We define adjusted EBITDA as EBITDA plus stock compensation, plus our reclamation accretion, less the effects of our equity method investments. So, Hallador experienced a net loss of $3.7 million for the quarter, a $0.12 a share and for year-to-date, we had a loss of $100,000 or basically $0.00 a share. Our free cash flow for the quarter was $1.1 million, $21.7 million for the year. Our adjusted EBITDA was $10.5 million for the quarter, $52.1 million year-to-date. We paid down our debt, $1.1 million for the quarter; $16.5 million for the nine months and we paid dividends of $1.2 million for the quarter, $3.7 million year-to-date at $0.12 a share for the– or for the year, $0.04 a share for the quarter. Our bank debt at 9/30 was $172 million. Our net debt was $163.4 million at the end of the quarter. Our debt target for the end of the year is $160 million to $165 million and our debt-to-EBITDA coverage ratio is 2.43 times. I'll now turn the call over to our CEO, Brent Bilsland.

Hi, everybody, and thank you for joining our call. I am pleased that Sunrise had strong shipments during the quarter at 2.1 million tons. That puts Hallador on pace to ship 8 million tons in 2019, which is a record for our company. Unfortunately, our strong shipments were overshadowed by three temporary events that led our cost to increase by $3.86 for the quarter. First, our Oaktown 2 mine experienced challenging mining conditions during the quarter, but was able to return to what I would describe as good production by early October. Second, Carlisle has been working hard to reduce its cost structure since reopening in late 2018. During the quarter units were relocated and in October, both production and recovery improved dramatically, so much so that Carlisle experienced record production, up 40% during the month of October. Lastly, our Ace in the Hole Mine had planned a new box cut development in a new mining area and that led to low production during the quarter. We believe these events to be isolated to the third quarter as we experienced record company-wide production during the month of October. Thus, we anticipate our cost structure returning to our historical sub-$30 a ton cost structure. Looking at 2020, it appears to be a unique year. The coal export market is currently being pressured by a confluence of cheap liquefied natural gas and low-priced coal coming from Russia. Now the seaborne market has been growing each year at a pace of about 36 million metric tons. As long-term, the world needs Illinois Basin coal to go to the export market. So I believe the current market conditions are the equivalent of a lightning strike at your Kid's soccer match. Everyone has to return to their cars and wait a little while. While the Illinois Basin domestic market is experiencing return of several tons that were exported in previous years, these tons are returning and pressuring high-cost producers. In 2018, the Illinois Basin produced 106 million tons roughly. In 2019, we have seen 10 million tons of Illinois Basin production, either closed or has announced to be closed. We anticipate that once the sales season wraps up this month there will be further relocation of contracts moving from high-cost producers to low-cost producers and followed by further mine closures. Now, when the lightning strike occurs, you lose some time, but the game goes on. The seaborne market for coal is still growing and the Illinois Basin will soon be needed to return to the export market, but a couple of players will have gone home. Hallador is in good position to profit from the current market. We have 7 million tons sold for 2020. This represents 88% of our projected 8 million tons for 2020. Longer-term, we are 75% sold through 2022. Additionally, once our banking partners reviewed our solid sales position and could clearly see our future cash flows, they agreed to extend our credit facility to September of 2023 and reduced our interest rate by 50 basis points. Thus Hallador has improved its low-cost capital structure at a time when others in the industry have only have access to capital at exorbitant prices. With that, I am going to open the call up to questions.

[Operator Instructions] Our first question comes from Lucas Pipes with B. Riley FBR.

Hey guys. Thanks for taking my questions. This is Dan Day on for Lucas. Just a quick question, one of your peers that's already reported has talked about consolidation in the industry. Where do you guys think Hallador fits in the M&A talks that are currently ongoing? And just maybe any thoughts on the Murray bankruptcy and how that affects the market in the ILB as well. Thanks.

All right. So two questions. Where do we fit in the consolidation of the Illinois Basin market? I think that we agree that the Illinois Basin will continue to consolidate. We kind of see 2020 as a year where the market demand is pressured. So supply will get corrected. And in 2021 or perhaps even late 2020, we think it's likely that the market re-expands and we see export markets continue to grow and we see gas prices continue to rise. We think both the export market and both natural gas prices have kind of recently been at unsustainable levels. So, we kind of see this constriction. What I think comes out of that is, some of the higher cost producers will not be able to place enough tons and that will force them to make decisions and some of those decisions we think, will be they'll sell their contracts to lower cost producers and close in high-cost production. I mean, I think that's what we are going to see. We happen to be in a really good spot. We are 88% sold for next year. And we're currently in the middle of the sales cycle. We've got this down to five or six different utilities. We are waiting to hear where we stack up in that group. What and how much business we are awarded. And I think there will continue to be sales throughout the year. I think we can see other producers also say that they think the export market gets stronger in the back half of 2020. We tend to agree with that because we think that's the long-term trend that we are going to see more and more Illinois Basin coal flow to the export market, which perhaps might make our market a little more volatile. And so, the second part of your question was what happens with the Murray bankruptcy? I think that there is a lot of issues going on there. It's going to be a complex, long drawn-out thing. But I think we'll let them speak for themselves as far as how that's going to play out.

Great. Thanks for taking that. So, you mentioned, you see, like export prices rising towards the back half of next year. What – like what do you think the most important catalysts are to get that price higher? Is it just lower ILB production, as higher cost producers take off-line? Is it may be less robust production of Russia? The LNG prices? What kind of needs to happen there or what do you see is like the top catalyst for higher API to?

Well, top catalyst, I think, would be a rise in LNG gas prices. Right now, I think we are seeing pricing that's unsustainable. And it's always a question, how long will it take for it to come back and that's why I thought it was such a good analogy about sitting at my kid's soccer game in a lightning strike. And then, you go back to your car and you sit there, and you know you are going to go back out. You know you are going to play. You just don't know, is that going to be an hour? Is that going to be a half hour? Is that going to be three hours? But – and to me, the export market is very much that same way. I mean it's got times that it's strong and times that it's weak. But we know that the overall trend is coal plants are being built around the world. And those plants continue to need coal to feed them. And the Illinois Basin has proven to be a low-cost exporter of that thermal market ton. So, we continue – we don't think anything has changed about that trend. It just happens to be a period where we got hit with low-priced LNG, because we had all these new facilities coming online at all the same time. At the same point, what caused Russia to suddenly say, we want to export a lot of tons cheaply. I'm not quite sure I know the answer to that. But, we don't think either are sustainable, because they aren't sustainable, we know that we have to return back to a long-term trend. The question is, is just how fast does that happen. Just for market data, different points that we see, it appears to us that the export market kind of unfolds in the second half of 2020 at this point in time. It's certain – that certainly can change. But that's what the tea leaves look like today.

Great. I appreciate your color. I'll just get one more in. Would it be possible or something that you guys might consider, given current market conditions to maybe look at your contract books, maybe just settle some contracts financially and then take off higher-cost production? Is that something you might consider?

I am not sure I understood your question.

So, just settle – like, say, look at your contracts, maybe settle up some of them financially, sort of just accelerate the supply cuts that need to happen and then move forward with lower supply from there.

So, I think you're asking, would we – to defer tons with customers, is that what you are asking?

No, just literally, like settle the contracts financially, like, as in rather than send the tons, like settle up financially to accelerate the supply response.

Yes. All of our contracts are mine-specific and none of them have any settlement clauses.

Got you. Okay.

We're not – I mean we're not selling number two yellow corn. We are selling Oaktown coal or Carlisle coal and it's not like you can buy them out or substitute.

Got you.

Well, I think more importantly is, is our customers haven't asked us to defer anything. Our customers still want the tons that they've committed to taking and our customers, we believe want additional tons to be purchased from us. So, we think there is some other players out there that have been in the export market in a big way on shorter term contracts. Those contracts have expired and now they are looking for where do they place those – where do they place those tons and there is not going to be a seat for everybody. The low-cost producers have a challenging time. But eventually, they'll figure out ways to get those contracts out of the high-cost producers and into their book. That's the consolidation, I think, other people are talking about. There is a lower-cost producer, buy out the contract of a higher-cost producer and get him to shut and ton it. We think we may see some of that. Time will tell. We may participate in some of that.

Well, that’s all I had. I really appreciate your color and best of luck.

Thank you.

[Operator Instructions] Our next question comes from Ethan Park with Extract Capital.

Hey, Larry. Hey, Brent.

Hi, Ethan.

Hi, Ethan.

So, we've seen a lot of companies in the thermal market both in public and private companies, and they've filed bankruptcy. We've seen forbearance agreements and we've also seen producers that are cutting production of various basins including in the Illinois Basin. And I know this was mentioned in your intro marks and the previous questions as well. But we just wanted to be clear, do you have any plans to cut production below eight million tons right now?

We currently have no plans to do that now. We'll have to get through our sales cycle and see where we end up contract position and we will adjust our production to whatever our sales are, whether that's more or less than 8 million tons and we could easily see a scenario where, let's say, we sell 7.5 here at the end of the year. We get further into the year and sell spot tons in the summer and fall months. That seems to be a trend that happened to us over the last two years. We continued to sell tons as the year went on. In fact, we just sold some tons few weeks ago. So, that's probably what it's more going to look like. We'll probably come out with sales a little less than 8 million tons. And then as the year goes on, I think we anticipate making spot sales. All of that is dependent on what did the export market do? What does gas prices do? We've seen a nice bump here in gas prices in the last week - week or two. And like I said, we are strong believers that there is a lot of Illinois Basin coal went to export and it will need to return there. The question is just how quickly are those markets going to come back into balance.

Okay. Thanks.

Thank you.

Our next question comes from Scott Caufield with Pacific Value.

Hey guys, I was hoping you could talk a little bit about capital allocation going forward. I know kind of debt pay downs has been a focus in the past, kind of Hourglass Sands. But given how depressed the share price is, would you look to doing buybacks here? Yes, thanks.

I think that our primary goal is to pay down debt. Once we get under two times debt-to-EBITDA, I think then, we will give stronger consideration to share buybacks. We certainly feel that our stock is a value at this price points, but, I mean, just look at the free cash flow. But – and we have such good sales position that we have great contract. We have great cash flow visibility in future years and that was part of the reason we went to market to refinance our credit facility. We had such a strong position when we showed it to the banks. They just felt very comfortable to extend our facility and not only that, lower the rate. I mean, I think you are seeing higher rates to other producers out there in the debt space and yet, we were able to lower our rates. And I think that speaks to, how comfortable our syndicate of ten banks was where they could really calculate out what our debt pay down and future cash flows look like. So, as far as how we allocate capital, right now, primary step number one is to continue to pay down debt. We know that as we delever our balance sheet, there is going to be opportunities arise in the market and we want to get ourselves in a position where we can take advantage of that.

As a follow-up though, would there be a price at which you would buy back? I mean, if you are $90 million or so market cap today, but you are talking about maybe generating, call it, $20 million to $40 million free cash next couple of years, that's already a pretty attractive multiple. How far would the price have to fall before you guys would step in?

Well, that's – I don't think we have a specific number on it today. It is something that we do look at and our Board looks at, and we've had those discussions. We feel that, that we will continue to make cash flow. We will continue to pay down debt and either our stock price will rise and we will buy the stock in when the time is appropriate. I think our initial concern is we want to be under two times debt-to-EBITDA before we would take that action. Now, obviously, if the stock price continues to fall, those decisions can change and that is something that we continue to look at on a quarterly basis.

Okay. And then, just kind of last question. Is there anything – are you guys still moving forward with investing in Hourglass Sands staying over in Colorado or is that kind of on hold right now?

So, we have a team out there that continues to work on that. We have to wait for the market to be in the right position for us to allocate capital at a return that makes sense for us. And so, we continue to work on that and we continue to wait for the market to get in position to where it makes sense for us to make an investment. So right now, we are not spending a lot of capital on it. It is something that we've learned a lot about. We have relationships in that field and we are looking at more than one deal in that space. But, thus far, we've not pulled the trigger on any – allocating any capital. When we do, we will make an announcement – if we do and when we do, we will make an announcement.

Okay. Thanks for taking my question.

All right. Thank you.

Our next question comes from Arthur Calavritinos with ANC Capital.

Yes. Thank you very much. Hey, I just want to get your perspective on the Nat Gas and the LNG. I've been on the calls with everyone. The LNG has hurt everybody like – and it's non-economic LNG going. And was it a result – I mean I know a lot of stuff came online abroad to ship it. But, was it accelerated do you think, because as you look into Q2 and you guys know better than I do and end of Q1 and I am sorry at the end of Q2, Q3, this Nat Gas price, I think we are at 2 – maybe 2.24 for a low or something. And did that really – did buyers really like accelerate their purchases to stock up when they saw that, because I am just trying to think this thing is not sustainable when we look at Nat Gas and you are right, we've had a bump up and I've seen – and just as a follow-up to that, I've seen a lot of big companies announce yesterday, today, large CapEx cuts in their budgets like, 50% in some cases, in large dollars. So just, those two points. Thank you.

Well, I think our general viewpoint on gas is, if you look at U.S. gas production, you've got 45% of U.S. gas production coming from the Marcellus, the Utica and the Haynesville. And the data that we look at shows that those guys have drilled their kind of Tier 1 – what do they call it, super prime and Tier 1 properties. Their best acreage is about 20% of their acreage and they're drilling that pretty aggressively right now. It looks like, to us, depending on the basin, two to three years and they've kind of worked through those best acreage positions. Now, that doesn't mean they won't find some more reserves, because I know they will. But it still looks like, to us, there is pretty good tremendous – there is pretty good upward pressure on their cost curve in the next couple of years. So, we don't think that the price of natural gas, when it gets down into the $2.20s, is sustainable. That the industry, in general, has been borrowing money and drilling on borrowed money and that capital source dried up in 2019. And so, now you're seeing those companies have to drill within their free cash flow. And as you said, I mean that's a significantly smaller number. So, unless we know this, the shale gas play has a pretty steep declines occur and so, if we see CapEx budgets cut in half, we know that drilling falls proportionately. And so, we should see a back-off of natural gas prices. When we see that, and that's kind of what we are talking about in this dynamic of the Illinois Basin is that, the front half of 2020 seems to be the constriction point of the market, right? We've got export tons coming home, looking for a home. They are going to push out high-cost tons. We know that low-cost producers are going to buy the contracts of high-cost producers and some of those high-cost tons are going to come offline and then at some point in time, we know or we believe that the export market comes back maybe in the back half of 2020 and we see gas prices start to rise. And all of a sudden now, the Illinois Basin, which was 106 million tons in 2018, we've had 10 million tons of supply announced to come offline. We are probably going to see another 5, 6, 7 million tons come offline. And then six, eight months from now, we think that all of a sudden, the market starts to go the other way and we need more tons to come out of the basin. But there will be less mines and less producers capable of doing that. So it's very easy for everyone to get very focused on the next six months. But if you look out longer-term, we are going to see consolidation in the industry. We are going to see high cost tons finally come off the market. And I think it could be a really interesting to see what happens to the space when you look out to 2021. In the meantime, I mean, look at the space, there is some high-quality names including ourselves, that have great free cash flow. The balance sheets are in healthy positions. Some people have better contract positions than others. That's where we think we are very strong. But even some of the low-cost producers will – they'll find a way through. So, to me, I think the space looks like a tremendous value, especially when compared against the balance of the stock market. You got the coal industry trading at 3.5 times EBITDA. You've got the rest of the stock market trading at 12.

No. No. No. I hear you. It's just – it's been painful. But you have this Nat Gas thing that, which is holding everybody back and then – and on the first part, right, when I look at Nat Gas and the LNG, I mean, did a lot of Nat Gas just gets shipped out via LNG mechanism, just because it was so cheap and the buyers really knew it? Or is it just like a - it was just a perfect storm? You used the term lightning strike earlier. But just you had all these LNG facilities getting built and guess what? Like, we are at $2.20-ish for Nat Gas and it was a perfect time even for people to accelerate purchases. I just – if you could speak a little bit to that part?

Well, I think, if you are going to build an LNG export facility, you are talking about $5 billion investment. Most people don't do that. I would argue, nobody does that without some sort of off-take agreements in place. And so, those tons are going to get shipped regardless of price. They are committed to ship them, right?

Yes.

So it's the remaining, say, 20%, that maybe someone speculated on that price. That's the – those are the times that are really pushing the market one way or the other. And so, people made commitments and speculated on, all right, we'll agree to take the gas and now they're kind of stuck in their position. They got to play it, they've got to place it regardless of what price and that's kind of pushed the market down into this, what we would call an unsustainable level. So that happened in the export market. Well, suddenly, all of a sudden you see Europe and other places flooded with cheap LNG and that's displaced the coal. So now the coal is kind of coming back to the domestic market to kind of wait for this LNG market to recover. We know that it has to recover, because these are unsustainable pricing. As far as the domestic gas production, the thing that has fundamentally changed in 2019 is, companies are no longer allowed to borrow – are no longer able to borrow capital to drill. They have to do so on free cash flow. They can no longer issue equity, because their stock prices have been so beat up to raise capital to drill. So they have to do it on free cash flow and it's hard to have much free cash flow at current gas prices. So that market will come back into balance. It just takes a little time. And unfortunately, I don't think anybody has the crystal ball on what exactly that timing is. To us, it looks like late 2020.

Yes, yes. No, you are absolutely right. And then, again, these CapExes cuts that were announced by three companies, I know that large were like enormous. And then, one other thing, you had a competitor, or another coal company, I should say in the Powder River Basin. And just last question, again, thank you for this. And they said something like for every $0.20 move in Nat Gas, the tons – and again, this is Powder River, that move are like enormous. So we've had basically two of those $0.20 moves since they reported earnings. Anything just to help me out as I think about Nat Gas moving up in terms of either displacement - are more coal - are starting to flow through? And that's it. Thank you.

I don't really have a metric to support their claim as to $0.20 move, what that equals to and PRB ton that's coming on and coming off. I think the market is far more dynamic than that. Because people have a tendency to look at the Henry Hub price and say, well, that's the price of gas. And then other people will say, well, okay, I'll look at the Chicago Citygate price of gas and say, well, that's the price of gas in my region and what really matters is, is what is the price of gas at the competing gas plant to the competing coal plant? And by the time that gets delivered, what price point is that at? And that's – there is a lot of transportation by the time you get to that point. So that's why it becomes infinitely more difficult to say exactly what that price point is. We've got – but we know, in general, we can hit certain price points and we've seen roughly what the Illinois Basin demand has been and then we've got to factor in what the export market has been. What I am saying is, I think the same – I think the Illinois Basin gets constricted to its tightest point in the first quarter of 2020. And then beyond that, it starts to re-expand. Now does that take two quarters for it to re-expand? Does that take four quarters to re-expand? I am not quite sure. We just see a lot of production coming off-line and we don't see a corresponding power plant closure in our backyard. So, we know that gas prices move really quickly. Gas prices will move up or down really quickly. But as they move up, because again, we think drilling is showing because the capital expenditure is going to flow, that gas prices have to rise. When gas prices have to rise suddenly, we have to burn more coal to meet the power demand, to meet the weather demand and we think, we are set up in a really good position to take advantage of that.

All right. Very good. Okay. Thank you for your remarks. Thank you.

All right. Thank you.

[Operator Instructions] At this time, we are showing no further questions in our queue. So, this will conclude the question-and-answer session. I would like to turn the conference back over to Brent Bilsland for any closing remarks.

Well, thank you, everyone, for joining the call. And I look forward to speaking to you next quarter. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.