SXC - SunCoke Energy

[snow pea]

(To echo Ben) Thanks for the commentary; I am also following with interest.

[RadMan24]

Looked at Mangrove. Interesting they own 10% stakes in a lot of distressed, unfavorable plays. Not sure if it's because assets have boomed or what but Westmoreland coal is one they invested 10%.

 

Management could get that terminal to work out okay this was a steal. Not sure if AK will go belly up, things may be improving here soon (1-2 years) in the steel industry. Really depends what China wants to do with excess capacity. Sentiment will likely change before fundamentals.

[Palantir]

Are you still expecting $250M 2016 EBITDA? If EBITDA is in line with guidance, then equity value will be a lot lower.

[Picasso]

I look at them consolidated. Guidance was lower than I expected but they threw in some bad outcomes and practically no improvement at Indiana Harbor because they overpromised in the past. I'd expect around $220 million consolidated and maybe down to $170 million if Convent flops. If there are no customer defaults and contract rejections then $250 million of EBITDA is probably a 2017-2018 story. 

 

SXCP is buying up a lot of debt at 60 cents on the dollar (other MLP's don't have that sponsor support or excess cash to do something similar) so there is some offset to lower EBITDA. Obviously biggest concern is a covenant breach.

 

edit: there are other MLP's with strong sponsor support and excess cash flow (like Phillips 66 or Shell midstreams) but they don't trade at 5x nor have bonds at 60.

 

$220 million @ 7x minus 2017 debt of $799 million (levered 3.6x) = $16 on 46.5 million units. 

$170 million @ 7x minus 2017 debt of $799 million (levered 4.7x) = $8.4 on 46.5 million units

 

Add in distributions on SXCP and I think it made a ton of sense to buy in the $5's.  Less so up here since SXC is still trading with assets and IDR's for free.  I'd much rather own SXC even though their future is mostly dependent on how well they manage customer issues at SXCP.

[indirect]

maybe light at the end of the steel tunnel

http://www.ft.com/intl/cms/s/0/76cb4804-c812-11e5-be0b-b7ece4e953a0.html#axzz3ytOAEmGr

[Picasso]

http://www.bloomberg.com/news/articles/2016-02-04/arcelormittal-said-to-prepare-3-billion-euro-capital-increase

 

A fairly big capital raise, puts the MT contracts with SXC and SXCP in better shape.  If you can get $20 million of EBITDA out of Indiana Habor @ 7x, you are left with $88 million for the rest of SXC.  Current value on their SXCP units is $194 million; a years worth of distributions at the current dividend adds another $60 million.  Hopefully Indiana Harbor can get to a full $35 million of EBITDA (which would support the whole market cap here) but kind of pie in the sky.

 

I've been thinking there is a good chance SXCP cuts the dividend in half to accelerate share repurchases.  If SXCP was at $5, that would still yield around 24% and I could see the market pretty comfortable with that plus the faster debt repayment (not a big difference in EV/EBITDA between current price and $5).  I've been slowly selling out of SXCP and may buy some more SXC depending on where it ends up trading.  Already a big position in SXC and seeing other interesting things.

[Picasso]

Also Moody's downgraded all the debt of SXC/SXCP.  I don't agree with their assessment of the debt held at SXC (if SXCP goes belly up, I wouldn't consider SXC levered 5x) but here's their note.  There's a short holiday on the leverage ratios as the Convent terminal hasn't had a full year of earnings so I don't know why they consider it levered 4.5x for SXCP.  Not until Foresight and Murray blow up that is.

 

And then there is their rating on the remaining SXC debt.  I think there is a reason that debt trades near par.  I wouldn't consider that CCC+ debt but that likely further prohibits SXC from collapsing the MLP structure.

 

The downgrade reflects the continuing headwinds in the company's end markets, as steel makers continue to idle operations and cut back production. The company's EBITDA declined in 2015 on the back of declining sales in the spot market and above contract maximums, as well as operating issues at Indiana Harbor and the reorganization of Haverhill Chemicals LLC facility, which more than offset the $21 million contribution from the Convent Marine Terminal (CMT) acquired in August of 2015. At December 31, 2015, Debt/ EBITDA, as adjusted by Moody's, exceeded 5.0x for SXC and 4.5x for SXCP (including only a partial year contribution from CMT since acquisition date). We expect the leverage to decline below 4.5x on a consolidated basis in 2016, as the company enjoys full year contribution from CMT and free cash flows are directed towards debt repayment. Nevertheless, the B2 rating reflects the increased event risk of contract restructuring or reorganization by one of the company's key customers.

 

The ratings continue to reflect the stable business model of the company's coke making operations, which supply coke to the integrated steelmakers, including ArcelorMittal, AK Steel and US Steel under long-term take-or-pay contracts with cost pass-through provisions. We expect the company's cokemaking operations to show steady earnings generation in 2016, as the company's customers continue to honor their take-or-pay obligations. The ratings also reflect the company's recent decision to eliminate the dividend at SXC and direct cash flows towards deleveraging. We expect that in the event performance is weaker than anticipated, SXCP distributions would be reduced as needed to maintain leverage metrics within acceptable range.

 

The ratings further reflect adequate liquidity, as reflected in the SGL-3 rating. SXC liquidity is supported by $123 million in cash at December 31, 2015 (including $49 million at SXCP), roughly $90 million of availability under SXC's $150 million revolver due 2018, and $65 million available under SXCP's $185 million revolver due 2019. We expect SXCP to be in compliance with the restrictive financial covenants under their credit agreements.

 

The five notch downgrade of SXC's secured revolver reflects our expectation that almost all of consolidated EBITDA is now being generated at SXCP, which effectively places the revolver in a subordinated position relative to SXCP's debt. The B3 rating on SXCP's senior unsecured notes, one notch below the CFR, reflect their relative position in the capital structure with respect to claim on collateral behind SXCP's secured revolver. The B3 rating on SXC's secured credit facility and Caa1 rating on SXC's unsecured notes reflect their effective subordination to SXCP's debt with respect to claim on SXCP's assets.

 

The stable outlook reflects our expectation that the company will maintain Debt/ EBITDA, as adjusted at or below 4.5x by directing free cash flow towards debt repayment.

 

The ratings could be downgraded if liquidity were to deteriorate or if Debt/ EBITDA, as adjusted, were expected to exceed 5.5x.

 

An upgrade would be considered should the company's end markets stabilize and Debt/ EBITDA, as adjusted, were expected to be maintained below 4.0x.

 

 

[Picasso]

This has worked out pretty well.  If you just go on the current price for SXCP, SXC is probably fairly valued here.  Some good news needs to happen for SXCP at this point... Still negotiations on the FELP debt situation.

[benhacker]

Good work here Picasso.

 

Thanks again for sharing.

[Picasso]

It should also be noted that there has been significant recovery in the value of the weaker steel counter parties.  AKS bonds went from $25 to $60+.  I think you're looking at a really, really good chance that all the steel contracts are solid.  Only worry like I said is the coal customer but not the end of the world now that the steel counter parties are looking a ton better.

 

The sell side was valuing these on equivalent yields to counter party bonds so I'd have to think you'll get more sell side love soon.

 

SXCP looks less vulnerable as well and SXC still trades around an 18% FCF yield.  SXC probably starts accelerating buybacks as well now that things are looking better.

[enoch01]

Good work here Picasso.

 

Thanks again for sharing.

 

+1

[AtlCDore]

Picasso,

 

Great job with this stock.  Are you selling shares or holding? 

 

Thanks,

 

AtlCDore

[Picasso]

I still own a lot but I've sold about 70% of what I held.  I'm been buying SXCP here (not a lot of liquidity) because it's probably worth 40-50% more than it's currently trading now that the AKS counter party issues have significantly subsided.  You were getting all kinds of free optionality with SXC that's obviously gone away now that it's trading at $6.

 

There's a ton of reflexive behavior with the stock so in theory you can start looking at dividends at the SXC level in the future, the ability to collapse the structure, selling off certain assets, further drop downs giving more value to the IDR even if they lose half of Convent, etc... still a lot of good news that can happen.  But the Murray counter party risk remains, it just happens to be less than 10% of EBITDA (if you think FELP makes it but Murray doesn't) and with the deleveraging efforts not the end of the world. 

 

Like when MT floated a big bond (which made the Indiana Harbor asset better once that normalizes), we're probably going to see significant X/AKS equity issuance that will only make the counter party risk subside even more.  X and MT bonds are basically at par for the maturities that match the contract durations at SXC/SXCP.

 

tldr; I think SXCP is a better long here but SXC still trades at a very high free cash yield with no net debt and options to create more value

[Guest Grey512]

Picasso - Great job and I hope you've made a decent chunk of money.

 

[Picasso]

SXCP back to yielding 20%.  Crazy to think it was yielding over 40% not too long ago.  They're now halfway through the IDR holiday and the notes are back above $70.  Hopefully they stay at $70 or so so they can delever as quickly as they did in the last couple quarters.  Now that FELP is just about done working it out with the bond holders, only thing that can really derail the stock is AKS giving a two year notice. 

[Picasso]

SXCP notes are now trading about $75 versus hanging out at $58-60 (25%+ yields!) for weeks even as fundamentals improved.  It's going to slow down the pace of debt repurchases but they used an average of $70 as their guidance for the $100 million of additional debt reduction by end of 2016. 

 

The returns aren't crazy, but there looks like an opportunity in the SXC 2019 notes.  They've called in or retired about 90% of the $400 million outstanding so there isn't a ton of liquidity, but there's a good chance they call in the rest sometime this year.  They trade around $97, 7 5/8 coupon and the call price is $103.81.  I'm going to put out some $95 offers and see if they get some interest.  If SXCP continues to recover and they can get an MT counter party drop down (I think they want to to reduce the concentration of EBITDA around the coal export terminals) then you'll see them call in the 2019 notes.  That could easily happen over the next year which would produce somewhere between a 7-16% return.  If it doesn't happen, clipping an 8% coupon or 9% yield given their balance sheet doesn't seem terrible into 2019.  They'll be collecting over $60 million of cash from SXCP over the next year and they're already in a net cash position.  SXCP could go to zero in a couple years and it wouldn't impair these notes.

 

CUSIP on the 2019 notes is 86722AAC7.

[Picasso]

Another couple positives for SXCP.  AKS is doing a 52m share offering against 178m outstanding shares.  2018 AKS notes are already over par and the 2019 convertibles have gone from $50 to $116.  It also sounded like they are helping adjust delivery to AKS to better manage their working capital needs without changing the cash going back to SXCP.  So less likely we get some 2-year notice from AKS (some thought it would happen already)?  More importantly, they were able to buy $53 million face of debt for only $33 million.  They might have a new customer for the Convent terminal but nothing concrete yet.  I'm not as optimistic about that happening as management but we'll see..

 

There was a narrow road to continue paying distributions and reduce debt, but it looks like they can keep paying distributions no problem since EBITDA would need to drop from $212 million to $177 million before they had to worry again.  The SXC cost holiday worked out pretty well for all shareholders.  This might be one of those rare situations where a 45% distribution yield was actually sustainable.  I took my entire SXC position and rolled it into SXCP and now I'm earning over a 100% yield on my initial invested capital in SXC.  And it was a pretty big position... It worked out in that SXC moved first and for some strange reason SXCP lagged (FELP?).

 

Once the FELP thing is over and done with, it can probably send SXCP up another leg to the mid or high teens.  When adding in distributions, still not a bad return.  Not sure how many guys are still in this trade but I'm still heavy in SXCP.  I'm thinking about hedging with some puts on SXC/AKS/X but I'll wait until FELP is done and these steel names finish up their share offerings.

[RadMan24]

You really think it was FELP?

 

Regardless, what a niche. Management did what they could do, could also pay off handsomely down the line

[RadMan24]

To expand, it definitely was a confluence of things. You had US Steel halt production, AK Steel at a dollar a share, no confidence in the industry, coal on the brink of collapse, which it did (yet people still panic even though its expected). What else, ovens that weren't at full capacity, take or pay contracts being questioned in oil and gas industry.

 

Take it all together and throw in Suncoke and bam.

 

Nice job, still a ways to go, but the price point you got in, when the fear was at its height, and risk at its lowest, provides you with ample margin of safety and returns at this point. Heck, didn't you also warn about ZINC?  That ended up in ruin.

[Picasso]

FELP and Murray were 25% of SXCP EBITDA so that was a big overhang on the partnership units.  A lot of the steel counter party risk fell, which was pricing into SXC, but SXCP lagged and I think that was why. Heck that is still the case...

[Picasso]

Oh yeah, when SXC was trading around $2 there were a ton of other issues.  Sadly no insider buys or share repurchases either.  So they were probably scared out of their minds as well.  That probably helps contribute to those big downside moves; they were fine repurchasing shares much higher then just stop when it's the best time to buy them.  I give them an A+ on front loading debt repurchases over the past couple quarters but an F- with share repurchases.  Maybe a D+ for buying Convent (only reason it's not an F- is because it gave me an opportunity to buy fairly low, but a terrible capital allocation decision ahead of some tough steel markets).

[Picasso]

SXC dropped their sponsor support of SXCP for the 3Q.  Interesting that they're doing it ahead of the FELP tender.  I recall management saying they did the support primarily because of the FELP/MEC issues.

 

Which means SXC may start repurchasing shares of reinstituting the dividend soon.  Current price on SXCP doesn't give SXC much credit for their other assets.

[Oreo]

Well done to all who added to their positions (especially in the winter). Took ba##s of steel given what the chart was doing. I admit to missing the ride so far and sucking my thumbs.

[Picasso]

SXC filed a $500 million mixed shelf offering. Perhaps a sign of consolidating SXCP into SXC? 

[Picasso]

And Mangrove picked up more shares as an insider... Already their largest position.