2023-06-22 14:42:20 ET
Summary
- CONSOL Energy's share price remains close to its all-time high despite pressure on coal prices and a predicted decline in US coal production.
- The company has adapted to the challenging market by focusing on the export market, where demand remains strong, particularly in the industrial sector.
- CEIX achieved record sales of 6.7 million tons of PAMC coal in the first quarter of 2023, with 66% of total realized coal revenue coming from the export market.
- The company has an aggressive shareholder distribution plan consisting of buybacks and a juicy dividend.
Introduction
CONSOL Energy (CEIX) is defying gravity. While the stock hasn't gone anywhere since the summer of 2022, the coal miner is extremely resilient, as its share price is close to its all-time high, despite tremendous pressure on coal prices.
The chart below shows the relationship between CEIX and ICE Newcastle Coal futures, which I use as a benchmark for international coal.
TradingView (CEIX, ICE Newcastle Coal)
In this article, we'll dive into CEIX and the coal market to assess the risk/reward of current prices.
So, let's get to it!
What Is CONSOL?
CONSOL Energy has a $2.4 billion market cap, which makes it one of the biggest North American coal producers. Headquartered in Canonsburg, Pennsylvania, CONSOL Energy is a leading producer of high-quality bituminous coal. That's coal primarily used as thermal coal.
The company has a history that goes back to 1864 when it started as a coal producer in the Appalachian Basin. It became an independent, publicly-traded company in 2017.
Now, the company's core business consists of three major pillars.
- Pennsylvania Mining Complex : The PAMC consists of the Bailey Mine, Enlow Fork Mine, Harvey Mine, and Central Preparation Plant. It has extensive reserves of high-quality coal and utilizes advanced longwall mining systems to achieve high production volumes at low costs.
- CONSOL Marine Terminal : Through its subsidiary, CONSOL Energy provides coal export terminal services at the Port of Baltimore. The terminal offers storage and loading facilities and benefits from being served by both Norfolk Southern ( NSC ) and CSX ( CSX ) railroads.
- Itmann Mining Complex : The Itmann No. 5 Mine in West Virginia is designed to produce high-quality, low-volatile coking coal. The preparation plant has a rail loadout and the potential to process additional tons from third-party sources, supporting the company's growth.
CEIX 2022 10-K
The newly constructed Itmann Preparation Plant began coal processing in late 2022 with the aim of producing high-quality, low-volatile coking coal. The complex also includes a rail loadout and has the potential to process additional saleable tons from third-party sources, providing opportunities for growth.
CEIX Is A Cash Machine
As the chart in the introduction showed, coal is facing headwinds. The main issue is slowing global economic growth and the fact that the Northern Hemisphere had a very mild winter, which caused natural gas inventories to remain high. The feared winter after Russia shut down natural gas exports to Western Europe did not happen.
Energy Information Administration
According to the US Energy Information Administration ("EIA"), the production of coal in the United States is expected to fall by 6% in 2023, reaching approximately 560 million short tons ("MMst").
Furthermore, the EIA predicts a further decline of 14% in 2024, with coal production dropping to around 480 MMst.
This downward trend is primarily caused by a projected 19% reduction in coal consumption by the electric power sector in 2023.
However, the demand for coal from overseas markets is expected to continue providing support for US coal production through exports.
CEIX confirms this, as it highlights the massive pipeline of new coal products in emerging markets. I believe that these trends could be further fueled by a potential steep rise in natural gas and oil prices the moment economic demand bottoms.
With that said, despite global pricing and demand headwinds, CEIX is doing very well.
In the first quarter of 2023, CEIX experienced a muted domestic coal burn due to the aforementioned warmer winter and related decline in natural gas prices.
However, the company's marketing team adapted and increased its focus on the export market, where demand remained strong, particularly in the industrial sector.
Hence, CEIX achieved record sales of 6.7 million tons of PAMC coal, with an average realized coal revenue per ton sold of $84.32, compared to 6.5 million tons at $59.60 in the same period last year.
Sales into the industrial export market surpassed sales into the domestic power generation market for the first time in the company's history, which is a remarkable development.
Overall, sales to the export market accounted for 66% of the total PAMC realized coal revenue, including 33% from the industrial export market and 13% from the export crossover metallurgical coal market.
These developments highlight CEIX's ability to leverage its export marketing and logistic advantages to offset weakness in the domestic energy markets.
The chart below shows that the company went from 42% export exposure in 2020 to 71% export exposure in 1Q23.
Given that domestic demand is in a long-term secular downtrend, this ability is key.
As a result, CEIX reported a strong financial performance in the first quarter of 2023, with a net income of $230 million. This translates to $6.55 per diluted share. It's also the company's highest quarterly earnings per share level for the second consecutive quarter.
Adjusted EBITDA came in at $346 million, and free cash flow reached $221 million.
What's interesting isn't just its stellar performance but also how the company is spending its free cash. After all, like oil companies, most North American coal companies are now in much better shape and eager to let shareholders benefit.
Thanks to pricing and volume tailwinds in the past few years, CEIX has made significant progress in managing its balance sheet and capital allocation, which continued during the first quarter of 2023.
The company generated $221 million in free cash flow, with approximately 45% of it used to further reduce the gross debt level. As of March 31, the total net debt stood at $14 million when factoring in unrestricted cash and short-term investments. That's a 97% decline from 2021 levels - as seen in the chart below.
CEIX also retired its Term Loan B by making a $24 million discretionary payment and submitted a redemption notice for 25 million of its second lien notes, worth a total of $49 million.
These actions will bring the gross debt level to around $240 million, and the company expects to fully retire the second lien notes soon.
Furthermore, CEIX maintained a strong liquidity position of $384 million, despite a reduction in the revolving credit facility borrowing limit.
Additionally, the company repurchased 1.2 million shares of its outstanding common stock for $67 million and announced a dividend of $1.10 per share (6.7% yield).
The overview above perfectly shows the company's accelerating trend in debt repayments and share repurchases.
Share repurchases are now expected to accelerate.
Thanks to the near completion of its debt reduction goals, CONSOL Energy is now committed to returning a significant portion of its quarterly free cash flow to shareholders.
The company announced an increase to its enhanced shareholder return program, effective in 2Q23.
Essentially, CONSOL Energy plans to return 75% of quarterly free cash flows to shareholders. The focus of its return program will shift primarily to share buybacks instead of dividends. This decision is based on the attractive free cash flow yields at which the company's stock is trading, the tax efficiency of buybacks, and feedback from its shareholder base.
In other words, CEIX believes that its stock is severely undervalued, which makes buybacks way more attractive than dividends.
Looking at free cash flow yield estimates, we see that even if free cash flow falls to $440 million in 2025 (analysts are pricing in coal price normalization and lower domestic demand), the company would still have an 18% FCF yield.
In other words, if the market cap were to remain unchanged, the company could buy back 18% of its shares without needing debt or neglecting its operations. This number excludes the dividend. If the dividend were 8%, buybacks could still be 10%.
That's a stunning number.
It also explains why CEIX has done rather well, despite the implosion in international coal futures like ICE Newcastle.
It also helps the valuation. The stock is trading at less than 4x 2023/2024 expected free cash flow.
FINVIZ
The current consensus price target is $80, which implies an 18% upside. I agree with that.
However, I do not urge investors to buy at these prices. Given the volatility and economic risks, I would only buy CEIX on a steep sell-off.
Additionally, I have a correlated play, as I recently entered into a large natural gas trade . If my natural gas thesis is correct, CEIX will benefit as well.
With that said, while I will give CEIX a bullish rating because of my belief that coal demand and prices will be higher for longer, I am not encouraging people to buy cyclical coal exposure. Only consider buying it if you're familiar with volatile assets and aware of the drivers behind coal prices.
Also, make sure to wait for a correction. I wouldn't buy after the recent rally.
Takeaway
Despite the challenging environment for coal, CONSOL Energy has shown remarkable resilience and strong financial performance. With a focus on the export market and leveraging its marketing and logistic advantages, CEIX has managed to offset weakness in the domestic energy markets.
Furthermore, the company's ability to generate free cash flow and effectively manage its balance sheet is impressive, resulting in significant debt reduction and shareholder value creation.
Hence, CEIX plans to accelerate share buybacks, considering its stock to be undervalued.
While the stock currently trades at an attractive valuation, caution is advised due to volatility and economic risks.
Investors should consider buying on a steep sell-off and be aware of the factors influencing coal prices.
Overall, CEIX's performance and potential warrant attention, but prudent timing and understanding of the market are essential.
For further details see:
Consol Energy: A 7% Yield And Massive Buybacks