SXC - SunCoke Energy

[Picasso]

It was very cheap before so I'm not sure what cheaper than very cheap is. Super duper cheap?

 

I'm not sure how you lose at this price for either SXC or SXCP. But man do they trade like death. Bonds are holding up at $60 with what appears like further purhases from SXCP to delever.

 

Total market value of $275 million with over $110 million of FCF. Trading for 5.5x EBITDA if you use face amount on the debt but they're retiring it at a large discount fairly quickly.

 

Seems like the Arch Coal rejection of take or pay at KMI in bankruptcy started another leg down. Then the ETE deal looks in jeopardy. A lot of bad headlines but it seems priced in a long time ago.

 

Been looking at CEQP for a while and had a position that I sold on the rally after Raging took a stake. I think it's also interesting and have been diving into it as much as I can but there are a lot more pieces to that puzzle.

[Guest Grey512]

It was very cheap before so I'm not sure what cheaper than very cheap is. Super duper cheap?

 

I'm not sure how you lose at this price for either SXC or SXCP. But man do they trade like death. Bonds are holding up at $60 with what appears like further purhases from SXCP to delever.

 

Total market value of $275 million with over $110 million of FCF. Trading for 5.5x EBITDA if you use face amount on the debt but they're retiring it at a large discount fairly quickly.

 

Seems like the Arch Coal rejection of take or pay at KMI in bankruptcy started another leg down. Then the ETE deal looks in jeopardy. A lot of bad headlines but it seems priced in a long time ago.

 

Been looking at CEQP for a while and had a position that I sold on the rally after Raging took a stake. I think it's also interesting and have been diving into it as much as I can but there are a lot more pieces to that puzzle.

I couldn't resist the value today and tipped my toe in as a long.

[shhughes1116]

It was very cheap before so I'm not sure what cheaper than very cheap is. Super duper cheap?

 

But man do they trade like death.

 

 

Very understandable why they trade like death...

1. Excess steel capacity in China = ~100% of US steel capacity;

2. People seem to think that the world economy is slowing down;

3. Investors are fleeing MLP's;

4. Investors are fleeing commodity-oriented companies;

5. Investors are fleeing "yieldy" stocks;

6. Coal is absolutely hated as an energy source, for a variety of reasons (cheap NG, pollution, mountain-top removal mining)

7. Coal seems to be hated as a component of the steel-making process (why use coke when you can build a DRI facility that uses cheap NG?)

8. The proliferation of bulls**t ETF's (leveraged and unleveraged) covering MLP's, "yieldy" stocks, commodities, etc. seems to have magnified the effect of 1-7.

 

Basically, SXCP is the nexus of everything that is hated in the market right now...eventually, they will be less despised/hated by the market, and they will probably double. 

 

 

 

 

[Picasso]

I think there's a lot more than a double if those clouds clear up.  The start of the thread was basically what you said; it's everything people hate or are unwilling to own.  That said I've looked at this more from what they should be worth in some of the worst outcomes you could think of. 

 

As an example, X just postponed their big new EAF.  They're rationalizing their production and their cost of capital is way too high to start building out or maintaining new coke batteries, EAF's, and switch 100% off coal in favor of nat gas.  It's just not going to happen tomorrow and not when their cost of capital is this high. 

 

The market is implying a complete implosion in a very short time frame given how much free cash the equity holders are accruing on these contracts.  I don't see how it's that short of a time frame.

 

Based on where Indiana Harbor should be with ArcelorMittal as a decent credit counter party, you could arguably justify the entire market cap on SXC from that asset alone.  And it's not like SXC has any net parent debt aside from the AKS omnibus agreement which runs out in a couple years; their 55% stake in SXCP reduces that liability to some extent as well as hopefully giving some pricing support to SXCP.

 

7x EBITDA on $30 million from Indiana Harbor is more than the current market cap.  I don't know how long or how smooth it takes to get there, but I would be surprised if it didn't happen before the AKS 2-year notice window expires.  But this isn't like ZINC where you need Indiana Harbor to make sure it doesn't go belly up.  In my mind there is a greater than 50% chance you are either getting Indiana Harbor for free or the stake in SXCP. 

 

What amazes me is seeing the sell side throw out 10-12x EBITDA targets on SXCP at the top and now they're downgrading at 5x EBITDA.  We're only talking about a one year difference.  Most of these issues have been lingering for a while and we've yet to see any counter party fully default on their obligations to either SXC or SXCP. 

[RadMan24]

But why buy the coal terminal?? That is the only thing holding me back. Foresight may be doing okay, but they have said numerous times that exporting coal is a dead business at the moment.

[Picasso]

Yeah that wasn't a good deal but not the end of the world. They issued SXCP units much higher than the current price as a decent part of the deal. While not a great business at the moment there is a $50 million EBITDA floor which may change a bit but I don't see below $35 million of EBITDA based on what happened to the CLD take or pays. I think they did the deal to get them in the high splits on the IDR's.  They should have known the credit condition of Murray when they did the deal so that's got some explaining to do.

[indirect]

I think there is high probability that Foresight will not make it and would impact the terminal revenues.

[RadMan24]

I think there is high probability that Foresight will not make it and would impact the terminal revenues.

 

Foresight...may be a low cost producer but man they are leveraged.

 

Relying on take or pay on the terminal for coal contracts in this industry is no guarantee. I'm skeptical. I was all about this idea until I saw that and my heart sank. It may work out, but I've been following that coal sector for years, and thankfully I got out in 2012 because damn. Arch Coal is in Ch. 11, they can restructure anything as long as it pleases creditors. Peabody is likely to follow suit. Cloud Peak is on the fence. Foresight may be at the mercy of others if they can cut costs.

 

If you can counter with a strong argument why that terminal will work out, then you may have something here.

[Picasso]

I'll let you determine whether this is a strong argument or not, but I think the price/valuation and some of the unique aspects behind the relationships of SXCP to SXC and FELP to Murray offset the major negative which was buying an asset with a weak contract to a non-investment grade credit. 

 

We can start by looking at what SXCP paid to acquire the Convent terminal:

 

$82.4 million of SXCP common limited partnership units issued to The Cline Group, subject to a lock-up period which vests in four ratable installments over a four-year period

$115.0 million of seller financing at competitive market terms

$214.6 million to be initially funded with cash and revolver, termed out as appropriate, to maintain our targeted 3.5x to 4.0x leverage range

 

Cline took 4.8 million units as part of the transaction (around $17 SXCP basis on July 2015) which will be mostly restricted past some of these potential credit events.  If you think the current price on SXCP is rational, then they really paid around $355 million with $185 million drawn on a $250 million revolver.

 

Convent has two customers: Murray and Foresight. Murray owns the vast majority of Foresight having invested over $1 billion as part of their strategy to drop down assets into Foresight and take a bigger role in the seaborne coal market.  As part of this they very recently acquired a Columbian mine sold by Goldman Sachs to blend with their existing ILB coal production to earn a better margin.  http://www.wsj.com/articles/goldman-sachs-sells-colombian-coal-mines-to-murray-energy-1439518460

 

If you're familiar with Bob Murray, he's not someone who is just going to roll over and die tomorrow.  Both Murray and Foresight have spent a lot of capital getting to the point where they are among the lowest cost coal producers.  As for what this means for Convent, I think his quote from that article states his intentions:

 

The St. Clairsville, Ohio, company is venturing abroad for the first time because the industry is “under attack” in the U.S., the company’s chief executive Robert E. Murray said in a statement.

 

“We must look to international markets to ensure our survival,” he said.

 

So will Murray decide they are going to drop out of the international market after saying how critical that is to their survivability?  First you will need to see Murray and Foresight reject the Convent contracts in bankruptcy (there is no other way out of them) and the subsequent business strategy will need to be 100% U.S. focused.  That doesn't sound like a winning proposition to me but it does seem likely that you will see some volume cuts as long as their seaborne rates stay this low (which they probably will).  Instead of $60 million of EBITDA it might be $30 million of EBITDA to SXCP if they cut down volumes and extend out the term.  It really hinges on whether you believe the international market has value to Murray/Foresight via Gulf Coast ports.  The actions by Murray and Foresight do make it seem like it is a high probability strategy moving forward.  I mean here is a description from the Foresight 10-K:

 

Our operations are strategically located near multiple rail and river transportation access points giving us cost-competitive transportation options. We have developed infrastructure that provides each of our four mining complexes with multiple transportation outlets including direct and indirect access to five Class I railroads. Our access to competing rail carriers as well as access to truck and barge transport provides us with operating flexibility and minimizes transportation costs. We have access to a 25 million ton per year barge-loading river terminal on the Ohio River, which was contributed to us in February 2015 by Foresight Reserves and a member of management, and contractual agreements for a minimum of

9 million tons per year of export terminal capacity in the Gulf of Mexico, including a terminal owned by an affiliate. We also have long-term, fixed price transportation contracts from our mines to both of these terminals. These logistical arrangements provide transportation cost certainty and the flexibility to direct shipments to markets that provide the highest margin for our coal sales.

 

You can draw from that what you want, but there is some element to Convent being a critical vendor to both Murray and Foresight unless they abandon their current international strategy altogether after they file for bankruptcy.  Perhaps the creditors decide they need to abandon that strategy.

 

There is also a "default" on the Foresight bonds after the Murray change of control.  They only gave notice several years after those bonds lost value so I suspect it's some kind of negotiating tactic, not really something where they want to send Foresight into bankruptcy but I could be wrong.  It's something I've been looking into more, but that has driven down the price on Foresight equity and debt (along with the distribution cut) more than anything.  It's my belief that they settle with the bondholders who gave notice and start repurchasing debt in the open markets to reduce leverage (similar to SXCP) and avoid breaching covenants.  But the first step will be to settle with those bondholders otherwise those bondholders will have a very uncertain path in bankruptcy courts. 

 

Also Foresight doesn't have a large float so it's more orphaned than even SXCP.  I actually think at the right price it may make sense to take a close look at FELP since there is a strong incentive for Murray to reverse this slide and save their large and critical investment.  I just happen to think it will involve some element of dilution to settle some debt worries and get to the finish line.  In that kind of situation the take-or-pay contracts at Convent are still in force. 

 

Now let's say the worst happens and in a couple years we lose $30 million of EBITDA from Convent.  SXCP would be left with around $180 million of EBITDA.  They current have $899 million of debt, so levered 5x.  Since their debt trades at $60 (if you look at trading history, they are very active buying back their debt in the open markets) it will only take $54 million of cash to keep them from breaching a covenant if they use that cash to repurchase in the open market.

 

One of the funny things about SXCP versus say KMI is that there isn't a need for all kinds of growth capex.  They generate over $100 million of free cash flow so we aren't looking at a situation where being locked out of the capital markets is going to cause this to head to zero if they lose half their profitability from Convent.

 

Also keep in mind that SXC has no net debt, can lever up 5x EBITDA, currently has debt trading at 7% yields, and is redirecting their cash flows back to SXCP to support that asset.  They know there is a chance that either (or both) AKS gives notice or FELP/Murray restructure within the next couple years.  In the case of AKS they have the omnibus agreement which won't cause a covenant breach, but FELP/Murray might.  I got the sense that FELP/Murray was the reason why they decided to support SXCP more than anything else so your worries are justified IMO. 

 

Now compare those outcomes to the current share prices and valuations and that's where I get comfortable with the situation.

 

 

[Picasso]

And here is a simple exercise for some back of the envelope in the worst possible situation.  Let's say SXCP cuts the distribution and reduces debt because they lose AKS and FELP and Murray.  I'm assuming an average repurchase price on the debt of $60.

 

2016:

Free cash flow: $110 million

Starting debt: $899 million

Debt repurchases in 2018: $183 million

 

2017:

Free cash flow: $110 million

Starting debt: $716 million

Debt retirement in 2018: $183 million

 

2018:

Free cash flow: $50 million

Starting debt: $533 million

Debt retirement in 2018: $83 million

Ending debt: $450 million

 

So in 2019 we have SXCP with $450 million of debt and somewhere over $100 million of EBITDA assuming a complete loss at all three bad customers.  But we also have SXC assets which should be able to do at a minimum $30 million of EBITDA with stronger counter parties.  So the complex would have around $130 million of EBITDA and it's been worth 10x in the past (you already got rid of the stuff people hate), but at 7x it has a value of $460 million for the equity and be trading at an 11% free cash flow yield with several more years on the take-or-pays.  It trades at $264 million today for SXCP and pretty much no value for anything SXC owns.  Basically to lose bad stuff needs to keep happening for the next 5+ years every freaking year.  It is possible....  But at this price I think you account for a lot of these potential negative outcomes.

 

One issue I have with any model going out to 2019 or 2020 is that we have to see another recession or something.  It's been a while since we've had one.  But just as a sanity check I think those really bad numbers help frame the downside even though it needs to be monitored closely.

 

Edit: And if the argument becomes that the debt might be worth more in a year or two (back to par), then it's most likely because we won't be having a discussion on all the potential negative outcomes and a lower cost of capital will dramatically improve the values of SXC/SXCP plus give some value to the non-valued IDR's which are already sitting in the high splits.  So weak capital markets will help out as long as we have a couple years before things can totally hit the fan.  If it happens all this year then this idea is screwed.

[Patmo]

Sounds like a good potential reward for the risk taken at these levels. If there's something that makes me giddy it's ugly names and the pain that comes with them. I must be masochist..........

 

I don't understand this situation well at all though, I'll be getting on you guys' bus (read: Picaso)  for this one so I'm keeping it small. I'll be a good boy and read up beyond a few forum posts though, it looks like an interesting company. Any suggestions on where to get started for efficient reading?

 

Cheers for the idea guys, hope for you large holders it turns out well  8)

 

 

 

[KJP]

Sounds like a good potential reward for the risk taken at these levels. If there's something that makes me giddy it's ugly names and the pain that comes with them. I must be masochist..........

 

I don't understand this situation well at all though, I'll be getting on you guys' bus (read: Picaso)  for this one so I'm keeping it small. I'll be a good boy and read up beyond a few forum posts though, it looks like an interesting company. Any suggestions on where to get started for efficient reading?

 

Cheers for the idea guys, hope for you large holders it turns out well  8)

 

As a relative newcomer, I found the recent investor day presentation, along with some of the investor day audio very helpful.

[jmp8822]

Picasso or anyone -

 

Any thoughts on the recent trading of SXC and SXCP?  Any reason why the market is paying you to buy SXC, net of its SXCP ownership?

 

Also, unbelievable the value of buybacks at SXC right now. The only thing with this idea that is giving me pause is the debt levels at SXCP relative to how fast they can buyback the debt.  The SXCP distribution cash flow could swallow one-third of the debt this year if they eliminated the distribution, but of course SXC us relying on that to some extent as well.

[Picasso]

SXC shouldn't need very much cash. I think the idea is to divert as much cash as possible to SXCP to reduce leverage in case bad things happen to Foresight, Murray or AKS gives a 2 year notice.  Supporting the value of SXCP is the most important thing for SXC to do right now, especially since you can buy SXC at a negative value net of SXCP. At some point SXC needs to drop down Indiana Harbor with MT as a fairly strong counterparty which likely has value beyond the current market cap of SXC. That hinges on SXCP being able to economically take drop downs which isn't possible right now.

 

As for why the discount... It doesn't make sense to me at all. Either you short out SXCP here or SXC has to go up. Even the potential for the omnibus kicking in doesn't explain the difference.

 

Mangrove keeps buying and so am I. Not buying SXCP at these prices, just SXC.

 

I think one potential here is a 50% cut in SXCP distributions to accelerate debt repurchases. SXC can probably issue some debt to buy SXCP units and SXCP can use that cash to repurchase debt. Honestly they should probably be doing that right now.

[Picasso]

But yeah if SXC could repurchase their shares instead of supporting SXCP the numbers are staggering. They said they plan to be opportunistic with repurchases but it would be nice to see at least $20 million of repurchases a year. You could lose a contract, delever, and see SXC trade close to where it was a year ago. Problem is the leverage at SXCP and they have their hands tied to a certain extent. The Convent deal made that situation worse in my opinion even though it sent the IDR's in the high splits.  I almost think management should be fired for doing that deal. Not the end of the world deal but they overpaid and now they can't take advantage of these market conditions as much as they should be.

 

Foresight has until Friday to settle with bondholders on the change of control issue. We'll see what happens. Also curious to see if Mangrove puts out any proposals such as the sale of SXCP. There aren't a lot of buyers who could refi the debt and make a deal work. I think we just need to see accelerated debt and share repurchases and it's easy to get to the finish line.

[indirect]

Unless their is an extension Foresite's forbearance ends today. Should clear some of the uncertainty around SXC

[Picasso]

Another extension to the 26th from Foresight.

[Picasso]

An interesting arb here even if you don't like SunCoke. 

 

SXC owns 25.4 million units of SXCP and get their distribution in March. 

 

SXCP: 25.4 x 7.08 = $180 million

Net cash: $15 million

Indiana Harbor $10 million EBITDA @ 5x (really depressed numbers there) = $50 million

 

Based on 65 million shares that's value today of $3.76 compared to a market price of $2.50.  You'll have to pay out that SXCP dividend on the short but just thought I would mention it. 

[KJP]

An interesting arb here even if you don't like SunCoke. 

 

SXC owns 25.4 million units of SXCP and get their distribution in March. 

 

SXCP: 25.4 x 7.08 = $180 million

Net cash: $15 million

Indiana Harbor $10 million EBITDA @ 5x (really depressed numbers there) = $50 million

 

Based on 65 million shares that's value today of $3.76 compared to a market price of $2.50.  You'll have to pay out that SXCP dividend on the short but just thought I would mention it.

 

Doesn't SXC also have a potential off-balance sheet liability to SXCP?

[Picasso]

Yep it's tough to narrow that liability down because each day that goes by it gets smaller and they also own 55% of SXCP so their liability isn't as big as the potential payments to SXCP.  In that situation I would assume SXCP aggressively pays down debt with a partial dividend cut so it also kind of depends on what prices they can retire debt to know what value SXC gets for that SXCP guarantee. You also need AKS to not only file by 2018 but also reject the contracts.  Their bonds have been trading a lot better lately but it wouldn't shock me to see them take another leg down.  The numbers from X this morning weren't pretty.

 

Since I'm giving pretty much no value to any other assets at SXC, it should balance out that off balance sheet liability.  $50 million for Indiana Harbor is very, very low with MT as the counter party. 

 

That liability also means that SXCP has an incentive to continue some kind of distribution until Indiana Harbor improves.  Maybe half of where it is today?  A quarter?  As it stands now SXC is taking in $15 million of free cash a quarter from SXCP.  If it goes down to $25 million annually, that is still a 16% free cash yield on SXC without considering Indiana Harbor improvement. 

 

I don't think that liability is large enough warrant this spread.  Bigger risk is FELP/Murray.  They have another extension on the FELP debt negotiation but Murray bonds are trading like crap.  86% yields on 2021 debt and it's possible their FELP stake gets diluted to practically nothing.

[awindenberger]

Regarding the Murray bonds, I noticed that a couple of the issues trade around 100, but the last one is trading in the 20s. It this one related to FELP somehow?

 

 

[Picasso]

Not sure what you're looking at but no Murrray debt trades near $100.  FELP has bonds in the mid $80's but that's due to the potential repayment at the expense of FELP shareholders and Murray.

[Picasso]

Well that arb closed fast.

[benhacker]

appreciate your commentary here Picasso.

 

I don't have much to say, but just wanted you to know that silence isn't lack of interest.

[Picasso]

Just some general thoughts after the earnings report:

 

Something that I thought was interesting for anyone who can buy them:  they didn't buy any SXCP notes this year because of the blackout period but they repurchased $48 million face for $35 million of cash in 4Q.  The notes have drifted down to $56 and now that SXCP can start purchasing them, it's probably a good trade to buy those notes as well.  CUSIP is 86723CAC2.  These are 144A but sometimes its possible to buy the REGS.

 

They plan to keep $60 million of excess cash towards reducing debt, so at an average of say $60-70 there should be close to $100 million of deleveraging this year even if they keep paying out all of the current distributions on SXCP.  So we should see under $800 million of debt by end of 2016.  With now 46.5 million units @ $7, SXCP trades for around 5x EV/EBITDA on face amount by end of 2016.  Covenants trip at 4.5x, so to get comfortable with the downside you should see what gets you down to $178 million of EBITDA.  Convent terminal is obviously my concern but SunCoke has only 65% of capacity on that terminal in guidance and they are currently operating past full capacity.  I mentioned before that I expected maybe halfish on the downside for EBITDA on that terminal, so that might get us down to $190-200 million in a FELP/Murray restructuring if the contracts get rejected.

 

Mangrove has kept adding and it's now their largest equity holding.  I'm interested to see what kind of pitch they try to make for the stock or whether they stay silent and let it play out.  Now that they own more than 10% it'll be hard for them to exit without having some kind of liquidity event such as an acquisition or collapse in the MLP structure.