2023-09-21 10:15:04 ET
Summary
- Warrior Met Coal maintains an impressive balance sheet with a net cash position exceeding $400 million, equivalent to over 15% of its market capitalization.
- Warrior Met Coal's ambitious Blue Creek project aims to transform its operational efficiency, making it one of the most cost-effective metcoal operators in the industry.
- Investing in Warrior Met Coal aligns with two compelling trends: extensive infrastructure development programs and the reshoring movement, both of which are expected to drive significant steel demand.
Investment Thesis
Warrior Met Coal ( HCC ) has, in my opinion, one of the best balance sheets in the sector. To be sure, I estimate HCC's net cash position to roughly equal 15% of its market cap.
In this analysis, I explain how one should think about investing in a metcoal company, while specifically discussing HCC's near-term prospects.
Also, I shine a light on other noteworthy considerations, including how investors should think about its capital returns policy as well as some of the risks involved.
Furthermore, I compare and contrast HCC's capital return policy to that of Arch Resources ( ARCH ). And while they are both different and dependent on each investor's risk-appetite, I explain which one is my favorite.
Why Invest in Metcoal?
Metcoal plays a crucial role in steel production, and steel is crucial for modernizing infrastructure. Indeed, in recent years the U.S. government has deployed several massive infrastructure development programs, including the IRA (clean energy), Chips (semiconductors), and IIJA (infrastructure) bills.
The other trend that will lead to a significant increase in steel demand is reshoring. This is where companies relocate their manufacturing operations back to the U.S., they rely on domestically sourced steel for their production processes, construction projects, and infrastructure investments. This, in turn, supports the growth of the domestic steel industry and contributes to economic development and job creation within the country.
My point here is that the growth engine for steel is less tied to China's real estate market than many presently believe.
Why Invest in Warrior Met Coal?
Personally, I would not touch a commodity company that hasn't got a strong balance sheet. Thankfully, after a very strong metcoal pricing period in the past 2 years, but particularly in 2022, this has allowed the vast majority of metcoal companies to end up with very strong balance sheets. In fact, it's not only metcoal companies but thermal coal companies too, such as Peabody ( BTU ) that are in much better shape than they were a few years back.
On this aspect, HCC is probably the one that shines the brightest. Case in point, HCC has a net cash position of more than $400 million. Note, for this figure I've not only included its debt obligations but also its asset retirement obligations (''AROs''). Put another way, more than 15% of its market cap is made up of cash! This very high cash on its balance sheet provides HCC with substantial options, see below.
So far, the story is very enticing, right? Here's where the plot thickens. HCC is determined to expand its Blue Creek project. HCC believes that it will need to invest at least $800 million in capex over the next several years, and perhaps its final figure will be higher.
The advantage that this project will bring is that HCC will become one of the cheapest cost operators. More specifically, instead of transporting coal via an overland belt to a third-party-owned barge load-out facility, the company now plans to build a belt conveyor system to a railroad load-out. This change is expected to result in lower operating costs and faster coal transport to the port. Additionally, the company plans to build and operate its own barge load-out facility rather than relying on a third-party provider.
In practice, for investors that truly buy into the metcoal story, the long-term for HCC will be very strong. But for investors that are only thinking about the next 6 to 12 months, hearing about HCC investing in its own future at the cost of return capital to shareholders right now, may not be all that interesting.
A Lot to Do About Nothing?
Perhaps all this analysis is overthinking the situation? Case in point, I'm invested in Arch Resources because I want my very strong dividend and share buybacks . And while this stock has been a strong performer of late, I recognize that there are periods where it hasn't performed strongly and has lagged its peers.
Similarly, in the past 3 months, HCC has been this group's laggard, but it doesn't mean all that much. After all, as an investor, it's not about seeking to make the most money. It's about understanding the risks involved and with a firm grasp of the risk involved, one has what I call staying power.
Staying power means that you are not attempting to market time the best stock and switching horses all the time, but sticking with your investment for a prolonged period of time, and you'll make a suitable return.
After all, I strongly believe that compounding at 15% is a terrific return that even the best of the growth investors aspire to reach .
What are the Risks Here?
Some of the risks facing HCC include the fact that the price of metcoal is subject to global metcoal supply dynamics. Secondly, there's no doubt that metcoal's prospects are tied to steel production.
Fluctuations in steel production, particularly in major consuming countries like China, can have a profound impact on metcoal prices. Therefore, investors should be prepared for considerable price swings particularly if the company hasn't got a near-term capital return program to keep investors allured to the stock.
The Bottom Line
Investing in Warrior Met Coal is a top opportunity, driven by its exceptional financial strength. HCC boasts one of the sector's strongest balance sheets, with over $400 million in net cash, amounting to more than 15% of its market capitalization.
The excitement in investing with HCC stock lies in its alignment with two powerful trends: the surge in infrastructure development driven by government initiatives and the reshoring movement. As these trends propel steel demand, HCC's robust financial position positions it for sustainable growth and value creation. While the path includes substantial investment in its future, those with a long-term perspective are likely to find this journey with HCC rewarding as it harnesses the metcoal story's full potential.
All in, investors are probably paying around 5x next year's HCC earnings. A very cheap entry point into this sector, particularly given its rock-solid balance sheet.
For further details see:
Warrior Met Coal: Shining Bright Amidst The Coal Dust