2023-07-05 12:59:14 ET
Summary
- Warrior Met Coal's stock has delivered an 18% total return since our last article and the long-running strike between the company and the worker's union has ended.
- Despite a fall in coal prices, the company has managed to keep production costs low and has over $800 million in cash.
- Risks to the company include further global depression of metallurgical coal prices and a mishandled return-to-work process by the company.
Revisiting Warrior Met Coal
In December 2022, we first wrote positively about Warrior Met Coal ( HCC ), noting that, among other things, the long-running strike between the company and the worker's union could not continue forever, that the company was performing quite well despite having fewer employees on hand, and that the company was considerably undervalued in our opinion.
Today, the stock has risen around 18% (41% on a total return basis for the trailing twelve months), and management announced during the last earnings call that the strike and ended and the union had agreed to an unconditional return to work.
In this article, we will revisit the current situation at the company and whether or not our initial positive thesis remains intact. Let's dive in.
The Commodity Game
As we pointed out in our prior article, Warrior receives a lot of negative attention for the fact that it is a coal producer. Part of this, we believe, is due to the common misconception among investors that all coal is created equal, while the truth is that it is not. Warrior exclusively produces metallurgical coal, which is of much higher quality than thermal coal (the coal which likely comes to mind when you first think of coal, and is lower in grade and cheaper). Unlike thermal coal, metallurgical coal is used exclusively for iron and steel production. Thus, its price is tied inexorably with the world's rate of steel production.
When we last wrote, the biggest macro concern for the company was that a looming recession (remember that?) would likely depress coal prices from their all-time highs. Prices have indeed fallen to around $250 per short ton in the first quarter 2023, but management, thankfully, wasn't asleep at the wheel during the boom times of 2022--the windfall resulting from these elevated prices meant that the company was able to declare a special dividend, as well as retain enough cash to essentially pay for its Blue Cree Mine project with minimal debt (the company currently has over $800 million in cash).
China's resilient steel industry has also been a welcome surprise to start 2023. CEO Walt Scheller noted on the Q1 conference call that Chinese steel production was up 7.3% while production in India (an emerging iron and steel powerhouse) was up 5.9%.
Of course, any time we invest in a company whose fortunes are so closely tied to a commodity, our top priority is understanding just how well the company will fare if hard times hit that particular commodity. In the case of Warrior, its ability to keep production costs low are best in class.
In the first quarter 2023, Warrior had cash cost of sales per short ton of coal or $118.87, compared with $119.23 in the first quarter of 2022. This ability to keep cost per ton low has a lot to do with geography--based in Alabama, the cost of moving coal via train a relatively short distance to the Mobile port is understandably lower than other mining operations that are more inland.
The Valuation & Looking Ahead
Since we last wrote about Warrior, not much has changed in terms of the company's forward valuations (i.e., the company still remains inexpensive in our opinion).
While up a bit from their lows one year ago, the stock still trades hands at an incredibly cheap 5.1x forward earnings estimates, and only 2.4x its forward EV/EBITDA. Given that the company has the potential to earn its market capitalization (about $2 billion) in the next five years, we feel that Warrior is underpriced.
Further, extracting resources from the ground is a game of efficiency: you have a product which is worth a certain amount today, and an operational way to hedge against the decline in price of that product is to be as efficient as possible. To this end, Warrior again performs quite well.
The above chart details the efficiency of the company's operations as expressed by metric short ton output per hour. We want to remind readers that the company has achieved these gains during a long-running strike. Our takeaway from this is that management has become quite adept at doing more with less.
Looking ahead, the company seems well positioned to take advantage of coal prices that have fallen from the sky-high range and back into the upper boundary of what could be considered normal. Scheller stated in the recent conference call that the correction of energy prices in Europe to the downside has prompted many steel producers there to restart idling blast furnaces. This is a positive sign for Warrior given that Europe is their largest geographical business segment.
The Bottom Line
It is difficult to say what catalyst could cause Warrior's stock to meaningfully re-rate--after all, coal and companies that deal in it have languished so long, along with investors, bemoaning the fact that they are so cheap that at this point they pretty much meet the definition of a value trap. Warrior, however, has a bit more going for it than most of its peers: the Blue Creek development has promise for investors down the line, while the return to work of its striking employees represents a possibly near-term catalyst in terms of production and efficiency. Aside from this, the pure return of cash to shareholders over time presents an interesting opportunity in and of itself.
Risks to our thesis include further global depression of metallurgical coal prices and a bungled return-to-work process that results in ballooning labor costs and heightened inefficiency. Given the track record of this management team, however, we think the odds are better that the execution will go according to plan.
For further details see:
Why Warrior Met Coal Is Still A Buy