2023-08-16 06:38:32 ET
Summary
- Warrior Met Coal Inc offers investment opportunity in coal production for the steel industry.
- Coal remains an important part of energy generation in the US, highlighting HCC's relevance.
- HCC's strong financial position and customer base position it for potential growth in the steel industry.
Investment Summary
Investing into coal more or less goes completely against the idea of us moving towards renewable energy sources, but it seems that we are still heavily relying on generating energy from coal and that does create an investment opportunity. I think that right now Warrior Met Coal Inc (HCC) is such an opportunity. The company has a focus on both producing and exporting non-thermal met coal for the steel industry.
In terms of generating energy from coal we still have around 20% as a source for it and the use of coal in the steel industry is broad. However, as the winds may blow I think that HCC will see strong demand and generate solid revenues and earnings for many years to come. With solid exposure to the growing steel industry in the US, I think that HCC offers a lot of potential here as an investment. The company isn't necessarily disturbing a lot of the FCF to shareholders, but I think with an FCF margin of 14% we are not that far off from it becoming a standard. I like the valuation of the business and will be rating it a buy.
Coal Remains An Important Part
HCC operates as a pure-play coal producer for the steel industry but I think it is also worth highlighting the actual reliance we have in our society on coal and its use for generating energy. The company has not been in operation for that long, only founded back in 2015. Operations focus on both producing and exporting non-thermal met coal to the steel industry to power their production. The customer base for HCC mainly includes Europe, South America, and Asia. Besides coal, the company also sells natural gas which comes as a byproduct of the extraction of coal.
Looking at a potential market for HCC to tap into, the American energy foundation still heavily consists of coal. Despite the renewable energy movement is undoubtedly presenting significant challenges to the coal industry. However, it's essential to recognize that despite the push for renewables, a substantial proportion of the United States' energy is still derived from coal sources. This underscores the continued relevance of coal-based energy generation, a factor that directly ties into HNRG's operational focus.
While the momentum toward renewables is undeniable, the energy mix in the United States reveals that coal remains a significant contributor. As of February 2023, an impressive 20% of the nation's energy is derived from coal. This statistic serves as a reminder of the intricate interplay between various energy sources and the practical considerations involved in maintaining a reliable and diverse energy portfolio.
Taking note of how the company managed to perform in Q2 of 2023 I think the targets the company set out and achieved are very impressive. Seeing the largest production volume says a lot about the market climate and still persistent demand. Besides that, the company is also maintaining a fantastic liquidity level, which is nearly half of the entire market cap. That sort of stability should come with a higher premium, presenting solid upside potential, which contributes to my buy case for the company.
Looking at the markets that the company works in, it's clear that Europe remains the large importer of non-thermal met coal from HCC. I think it's unlikely this will change as the rebuilding of Ukraine will require massive amounts of steel for the infrastructure. Steel that is powered and made from coal. Despite there being some short-term headwinds for steel in the European market, I think it will rebound and with HCC having a solid customer base here already they are in a perfect position to capture this demand.
Risks
Potential challenges to the buy case include an extended downward trend in metallurgical coal prices on a global scale. A protracted slump in these prices could adversely impact our formulated thesis and financial outlook for the subject company. It's vital to closely watch the various market dynamics and pricing trends within the metallurgical coal sector to ensure a comprehensive assessment of the risks at play. It seems however that coal is finding a bottom in terms of price, and the demand from various markets is likely to maintain the price at these levels without much downside. As for what happened in 2022, the war in Ukraine set many commodities ablaze as they rose in price, this was an inflated price level and it seems highly unlikely we will be returning there any time soon.
Another significant risk factor centers around the company's reintegration of employees into the workforce. A mishandled return-to-work process could inadvertently lead to escalated labor costs and heightened inefficiencies. This scenario might emerge from various factors, including inadequate workforce management, insufficient training for returning staff, or the inability to efficiently navigate operational adjustments required post-pandemic.
Financials
Taking note of the financials of HCC I think they are in a great spot right now. As mentioned earlier on, the liquidities that the company holds are almost equal to half the market cap, meaning nearly $1 billion.
The cash position sits at $827 and right now HCC could cover the long-term debts at least 3 times over which further underscores why the business is in such fantastic shape financially. With a small amount of leverage, I think it's reasonable and possible for HCC to take on further debt to fund new acquisitions of mines or facilities if they see a further increase in the market sentiment for coal. Such an announcement I think would be met by the share price increasing quickly.
Valuation & Wrap Up
Looking at the valuation of HCC, I think it is very appealing. The p/e is under 5 and in comparison to the broader materials sector it trades at a discount of 67%. This limits the downside quite a lot I think. Other coal companies tend to also trade at these lower valuations, which seems to be a result of the poor sentiment around the companies and the cyclical nature of the market environment they are in.
I don't think we are in for another large upswing in coal prices that would catapult the earnings for HCC. Rather, I think we will be trending steadily upwards as markets outside of the US continue placing strong demand on HCC to deliver. I like the performance of the company so far and the likelihood of both buybacks and higher dividends seems good. Concluding this article I am rating HCC a buy.
For further details see:
Warrior Met Coal: Coal Is Still Sticking Around For Some Time