2023-05-08 07:00:00 ET
Summary
- CONSOL Energy reported excellent Q1’23 results last week. Production and profitability are humming along at record levels and future initiatives are well underway.
- Management is completely dedicated to shareholder returns, now upping returns to equity of 75% of FCF.
- At a 2.4x EV/FCF valuation and with ~half of this value already contracted, shares are still much too cheap in my opinion.
- Risks always remain, but I am maintaining my full position and upgrading my rating for CEIX to Strong Buy.
We're not supposed to have favorites in stocks, but over the last several months CONSOL Energy ( CEIX ) has easily become one of my prized holdings.
I last wrote about the company in February, and noted its solid profitability, cheap valuation, and management team completely dedicated to shareholder returns with 35-50% of FCF allocated to equity.
Since then, the stock is up about +17% vs the S&P at +3.5%, and after releasing Q1'23 results on Tuesday, it is clear the bull thesis is very much intact. Management is executing extremely well, the equity's risk/reward remains excellent, and shareholder returns have now increased further, committed at 75% of FCF moving forward. I have maintained my full position in the company and now rate CEIX a STRONG BUY.
Below, I'll cover a bit about the quarter, outlook for the rest of this year and into 2024, and provide some technical analysis on how we might move forward. Those looking for a more in-depth background on the company can refer to my initial article. Thanks in advance for reading.
Q1'23 Results: Executing Well on All Fronts
Excellent ER, Valuation, and Operations
In their Q1'23 report just released on Tuesday , CONSOL Energy reported record quarterly net income, record EPS, and essentially 0 net debt, the lowest in the company's history by a wide margin. While I don't wish to just regurgitate the earnings release, some important numbers were:
- Net Income of $230.4m
- EPS of $6.55
- Free cash flow of $220.8m
This compares with a stock price of ~$62.50, market cap of $2.12B, and an EV of $2.13B with only $14m of Net Debt. Assuming roughly similar numbers moving forward, the company is trading at 2.3x EV/Net Income, 2.4x EV/E or P/E, and 2.41x EV/FCF.
With the company already having locked in 95%+ of its sales for 2023, and roughly 50% of sales for 2024, these metrics are even lower than meet the eye. With shareholder returns committed so heavily, the equity is trading much closer to a ~1x EV/FCF residual value 12-18 months from now.
While anything is possible, including adverse domestic politics, geopolitics, and natural disasters / mine safety incidents, this is just too cheap in my opinion. I've written about how the "death of coal" is misguided, and believe this, along with ESG pressures and institutional abandonment, is the cause for CEIX's absurdly low valuation. I rate the company a STRONG BUY from here.
I'll also briefly note here that the company used $98m to pay down debt during the quarter. It can significantly reduce this moving forward, as it only has $282m of total (gross) debt remaining and no significant maturities until 2025. With reduced interest expense, higher FCF to equity, and share buybacks underway, valuation metrics will improve daily without a corresponding equity price increase.
Operational Execution
The company's strong results came primarily from great execution at the company's PAMC - Pennsylvania Mining Complex, the company's main asset. Management has brought the Complex to its full 5 longwall capacity, of course boosting revenue but also driving margins higher as fixed costs are leveraged downward.
The Company also increased throughput at their wholly-owned Marine Terminal, as it has focused on debottlenecking the facility, increasing inbound capacity, and increasing its allocation of sales to the export market.
The below slide from the Company's quarterly presentation shows the record PAMC volumes, margins, and Terminal throughput. Investors should familiarize themselves with these numbers to better understand the Company's operations.
Additionally, the Company's new Itmann Mine Complex is expected to reach run-rate production of 900,000 tons by the end of this year, boosting production by ~3.5% in the immediate term with a potential doubling and more in the near future. Management says the "bulk of the spending [for Itmann] is behind us" and expects stable & profitable production in the immediate term.
Attractive General Supply & Demand
These results are well and great, but would be worthless if general coal market dynamics were poised for a significant and permanent crash. I always say anything is possible, but coal appears to be an attractive space to operate in for the foreseeable future. I will once more refer investors to my previous article on a thermal coal producer to understand why coal is in no immediate danger of permanently dying.
To summarize here, in short, commodity prices are often determined more by supply than demand, and global mining majors like BHP ( BHP ), Glencore ( OTCPK:GLCNF ), and Teck ( TECK ) are under intense pressure to wind down their coal businesses. Glencore, for example, has committed to closing " at least 12 coal mines by 2035 " in addition to already shuttering multiple in the last two years. These significant scale players matter the most to global supply and demand characteristics, and mean CEIX can operate in the margin, under the radar from ESG pressures but well within great profitability.
There is no simple substitute for coal now or in the near future, and closures from global majors will keep coal prices higher for longer . During the earnings call, in fact, CEIX management noted "there are no meaningful domestic coal plant retirements until 2028", and even despite this, has moved its focus toward the export market and industrial coal rather than domestic and thermal coals to reduce risk even further.
Increasing Shareholder Returns, Focused on Buybacks
The positive market supply and demand factors, coupled with the Company's record results and incredibly low valuation, has CEIX management committed to upping its shareholder return program. Already at eye-watering levels last quarter, management has now made their shareholder return target 75% of FCF . With the company's equity trading at 2.4x FCF, the company could theoretically buy back the entire float in just over 3 years.
As I have mentioned previously, this kind of capital allocation framework is the only correct strategy for a business valued in terminal decline, for an industry the world apparently does not want to grow at all. Management should be harvesting cash flows and not investing in new production.
To understand the magnitude of the shareholder return commitment, see the below chart. Management increased the share buyback program to $1B after Q1, leaving over $700m remaining on an EV of $2.13B. Investors should not underestimate or misunderstand the significance of the below - these are momentous step-changes since Q1'22 and even last quarter.
With the equity's absurdly low valuation, management is also taking another prudent step, announcing they are focusing on share buybacks over dividend increases. During the conference call , management said:
Our intent moving forward is to pivot our return program to mostly share buybacks. This decision is based on the attractive free cash flow yields at which our stock is trading, the tax efficiency of buybacks over dividends, and the feedback we received from our shareholder base."
This leaves me extremely excited as a shareholder. Barring a wild natural disaster or safety incident, and with CEIX's contracted sales, I believe CEIX has essentially "locked in" higher equity prices. I am very happy with my full position harvesting dividends and buybacks.
Technical Analysis - Bullish
Where might we go from here? Technical analysis is an imperfect science, but I believe it can hold good clues as to where security prices are going. If you check out my last article, price has actually pretty-well followed my green "upside" scenario. I hope that it does so again this time, though again this is nowhere near a crystal ball.
Here is my updated technical analysis on the CONSOL chart.
As you can see, my technical analysis leads me to believe CEIX could have a +55% run into September and leaves me an upside PT of around $100 by then. A more muted scenario would see the equity gain roughly 20% before meeting resistance and struggling to break through prior highs. I do want to note:
- The positive divergence in money flow (2nd panel, represented by green trend line) from the beginning of 2022, right before the stock's last 250%+ run. This means upside this year could have similar strength, though perhaps starting from a higher base means less percentage-gain.
- The negative divergence in the True Strength Indicator (a momentum indicator), meaning an upside run might peter out sooner than it did last year (3rd panel, the red trend line).
While technical analysis could easily support PTs even higher than $100, I think the scenarios above are realistic and relatively healthy expectations for what we could see in the near/immediate term. I will obviously be watching closely and will revisit into Q2 and beyond to see if we need to change price targets further.
Risks
It's always important to monitor risks and what can go wrong with any stock. It seems many of the risks to CEIX are the same as my last article, including domestic politics (higher taxes or mine closures), geopolitics (mainly a resolution to the war in Ukraine/Russia), and a global slowdown putting significant pressure on industrial/met coal.
While CONSOL's contracted sales would mitigate pricing pressure to the financials for the next 12-18 months, a decrease in coal prices would hurt future profits, terminal value, and, believe it or not, could decrease CEIX's multiple even further below its current valuation.
Additionally, in line with ESG pressures, many institutional investors are staying out of coal. Smaller shareholders may be less "professional" and could more quickly and willingly sell the equity in a market crash or downside scenario.
One final drawback/risk I see is that significant share buybacks decrease the equity float, which will invite volatility as fewer shares are on the market. Investors should not easily write off any of these real possibilities.
Summary and Closing
In summary, I think CEIX represents great risk/reward from here. I see upside of 55%+ for the remainder of this year and seemingly limited downside from the company's contracted cash flows and dedicated FCF to equity.
I am happily maintaining my full position and upgrade CEIX to a STRONG BUY; I will also try to remain somewhat indifferent and at arms-length to properly evaluate risks in the future.
As always, consider what's best for your own risk tolerance, time horizon, and overall portfolio before making any financial decisions. If you care to leave your thoughts or questions below, I do appreciate it and often try to be active in the comments. Thank you for your time and consideration.
For further details see:
Consol: Great Execution, Increasing Shareholder Returns - Upgrade To Strong Buy