CNXC - CNX Coal Resources

[TwoCitiesCapital]

Hello all,

 

I have been watching this name since Einhorn participated in the IPO earlier this year. I'm no expert on the coal industry myself, but have seen a few different write-ups across websites that all suggested the $15 IPO price was one that priced in distress and the double-digit yield was sustainable in the near-term.

 

For those unfamiliar, the general thesis was that Consol IPO'd CNXC with some of the lowest-cost, high quality coal mines available in the region. The mines themselves have 25-30 years of reserves at current production levels. The weakness in coal pricing and the over-supply in the region have contributed to pressure - but with large bankruptcies like that of Arch Coal, there is the potential for some of the higher-cost supply to come offline as companies are reorganized/restructured and may not need to operate mines at a loss to cover interest expense and etc.

 

The economics of the MLP were pretty attractive upon its IPO with contracted prices for 2015 supporting the cash flow to pay the dividend. Recent production cuts in the face of continued oversupply have called into question the sustainability of pricing that supports that dividend going forward, but there are a lot of incentives for the company to pay a hefty dividend if the situation normalizes. The common shares have to be paid $0.5125 per share per quarter before the subordinated shares held by the parent company get any distribution. In 2018 and forward, this dynamic has the potential to change  as Consol's subordinated units convert to common units IF distributions for the prior 3 years were $2.05 per share or more in each of the prior 3 years.

 

Obviously CNXC won't pay the dividend if there's no cash to pay the dividend, but the parent company doesn't receive any cash unless if shareholders get their $0.5125 a quarter and that subordination will continue until common shareholders receive a minimum of $2.05 a year for 3 years straight. I would say management is motivated to get those dividends paid as a priority if the cash is there to get out from underneath that subordination to the common. $55/ton thermal coal is necessary to maintain $2.05 distributions with the current cost structure of the company

 

Current thermal coal prices appear to be in the mid-40s, but I'm told CNXC receives a premium to spot for higher quality. I have not confirmed that for myself, but the company is basically break-even on cash costs at $50/ton and price any higher than that allow for upside through the yield. As an FYI, prices ranged from $50-60 in 2013/2014 but 2015 saw prices fall off a cliff to where they are at currently.

 

Anybody have any thoughts? This is just my preliminary look, but I figured we should start a discussion on it given the near 60% drop in recent months.

 

 

 

 

 

 

 

[ccap]

Like you, I have been tempted on this one.  Unfortunately, I don't feel like I understand the supply/demand situation in coal as well as I do in oil/gas.  Does all of the anti-coal legislation significantly impact things going forward?  Will power plants converted to nat gas convert back to coal if the nat gas oversupply ever resolves itself?  I'm interested to hear the insights others have on such things.

[wjsco]

The impact of anti-coal legislation does affect the coal industry going forward. coal has two main attributes - sulfur content and BTUs. Higher sulfur content equates to more pollution, and plants that use coal w/ high sulfur content have to buy expensive scrubbers for the exhaust (I think). So, two things - the new/cleaner coal power plants will reap outsized benefits, since their older/dirtier brethren are getting priced out (capex is too expensive, so they get taken out of the market), and cleaner coal will reap outsized benefits compared to dirtier coal (don't need to install the same pollution control equipment if you burn cleaner coal, which makes it more desirable).

 

Coal is not going anywhere - there is way more coal-fired installed capacity than nat gas (power plant wise). currently, nat gas utilization is abnormally high, and coal utilization abnormally low - nat gas prices are really low because, well you know why. And coal prices essentially mirror natural gas prices. Natural gas prices determine the spot rate for electricity, since natural gas-fired plants are the marginal producers (they produce the last MW of power required by the grid...nat gas plants can be fired up quickly, etc., which makes them good for handling volatile power loads. this contrasts with a coal plant b/c coal plants take forever to start and once they're going you don't shut them down - they basically handle the "base" load demand). Anyways, so nat gas prices decline, and electricity is a commodity industry - merchant power prices are basically cost-plus (spark spread, right?). So, Low natural gas prices pull the price of electricity down, which brings the price of coal with it, since coal is basically only used for electricity.

 

Couple of things to consider - there aren't many gas rigs operating in the USA these days. huge decline in the last 5-8 years...I think that liquid-producing wells ended up also generating a lot of gas, which explains why gas production increased through mid-2015 despite a massive fall in rigs. so you have a bunch of demand that is coming online, from new nat gas power plants, LNG terminals (sabine pass will be the single largest buyer of nat gas in the USA), export pipelines, etc., and supply is tied to oil production, which could stay depressed if the global glut persists. so there is a potential for a nat gas supply/demand imbalance in the USA (the solution to low commodity prices is low commodity prices). as nat gas prices rise, so too do coal prices. If that scenario doesn't happen, we have another interesting industry dynamic on the coal side. lots of supply is getting taken out of the coal industry. Illinois Basin, Central App have been hit especially hard, I think because Illinois has dirty coal and Central App has an unfavorable geology that makes costs increase. demand for coal is the lowest its been for decades, and it's still 30% of electricity production. so the demand is there, and the supply is coming out. Maybe La Nina will come to the East Coast next year, too, and that would certainly help CNX's customers destock a bit.

 

To summarize...yes, when nat gas prices rise, more coal-fired capacity will come online..just like, when nat gas prices fell, more coal-fired capacity went offline. clean coal producers, especially low-cost ones (like cnxc), will potentially benefit from the regulations as they cannibalize the bankrupt coal mining co's customers. the NE region is favorable b/c there's alot of electricity demand and utility infrastructure is somewhat lacking (I think).

 

Last point - the common unit dividend is covered more than 2x currently. The payout coverage ratio that they report (in the low 1s) is the coverage ratio for both the common and subordinated units, but to us it doesnt matter if the subordinated units are covered. at a >30% yield, and 3 years of basically guaranteed dividend payments, fairly low downside...

[feynmanresearch]

Like you, I have been tempted on this one.  Unfortunately, I don't feel like I understand the supply/demand situation in coal as well as I do in oil/gas.  Does all of the anti-coal legislation significantly impact things going forward?  Will power plants converted to nat gas convert back to coal if the nat gas oversupply ever resolves itself?  I'm interested to hear the insights others have on such things.

 

Take a look at our write up on ARLP for a deeper understanding of the coal industry:http://seekingalpha.com/article/3804196-why-alliance-resource-partners-is-not-as-attractive-as-it-seems

[RadMan24]

Like you, I have been tempted on this one.  Unfortunately, I don't feel like I understand the supply/demand situation in coal as well as I do in oil/gas.  Does all of the anti-coal legislation significantly impact things going forward?  Will power plants converted to nat gas convert back to coal if the nat gas oversupply ever resolves itself?  I'm interested to hear the insights others have on such things.

 

Take a look at our write up on ARLP for a deeper understanding of the coal industry:http://seekingalpha.com/article/3804196-why-alliance-resource-partners-is-not-as-attractive-as-it-seems

 

ALRP isn't even safe in this environment. Consol coal is probably going to survive, but there is a serious decline of coal use in the US. Therefore, prices will continue to drop until demand stabilizes, Consol is hedged and has one of the lowest cost mines, even with transportation included.

 

Because of the 30% yield, Consol the parent won't likely do any drop downs. That's the bad news, otherwise it could add some intriguing assets into the mlp.

 

If seriously interested, read every major US coal company report from 2011. You'll see who the knucklheads are, were, and how only a couple are well run. Alrp earned good retunrns on capital, but the industry sucks. Also; keep an eye on Arch Coal following ch 11.

[BeerBBQ]

 

"Because of the 30% yield, Consol the parent won't likely do any drop downs. That's the bad news, otherwise it could add some intriguing assets into the mlp."

 

 

 

Why is not doing drop downs a bad thing? Wouldn't it be better to have the company run for cash as opposed to growth?

[feynmanresearch]

Like you, I have been tempted on this one.  Unfortunately, I don't feel like I understand the supply/demand situation in coal as well as I do in oil/gas.  Does all of the anti-coal legislation significantly impact things going forward?  Will power plants converted to nat gas convert back to coal if the nat gas oversupply ever resolves itself?  I'm interested to hear the insights others have on such things.

 

Take a look at our write up on ARLP for a deeper understanding of the coal industry:http://seekingalpha.com/article/3804196-why-alliance-resource-partners-is-not-as-attractive-as-it-seems

 

ALRP isn't even safe in this environment. Consol coal is probably going to survive, but there is a serious decline of coal use in the US. Therefore, prices will continue to drop until demand stabilizes, Consol is hedged and has one of the lowest cost mines, even with transportation included.

 

Because of the 30% yield, Consol the parent won't likely do any drop downs. That's the bad news, otherwise it could add some intriguing assets into the mlp.

 

If seriously interested, read every major US coal company report from 2011. You'll see who the knucklheads are, were, and how only a couple are well run. Alrp earned good retunrns on capital, but the industry sucks. Also; keep an eye on Arch Coal following ch 11.

That's the argument we put forth in the article-even ARLP isn't safe

[wjsco]

Well yeah there is a serious decline in demand, but the question is if the decline is permanent or transitory. The IEA seems to think that the USA will use coal for >30% of its power for decades to come.

 

Coal demand is low bc natural gas, it's direct substitute, is so cheap. if nat gas were to stay at these prices forever, then i would agree that coal is on the way out. But, there will be a lot less nat gas production in the USA at $60 oil (much less $27) than there was at $100+, obviously, and a ton of new demand is coming online in response to the fracking/nat gas boom.

 

At the same time, there have been like zero new coal mines opened in the US in the past 3-4 years, and alot of production is getting taken out by low nat gas prices (or, low coal prices). So, you have production declines/mine closures from all of the bankruptices and no new supply coming online, which is the supply side. The demand side will be driven by normalization of natural gas prices...you don't even have to be a nat gas bull, you just have to acknowledge that commodity prices mean revert.

 

The pain in the coal industry is intense right now. Obama+EPA is driving restrictions on installed coal capacity, as well as the types of coal that are mined (indirectly - e.g., clean coal is preferable to a utility than dirty coal). The China slowdown and strong USD tanked the met and thermal coal export markets, which hurt a ton of companies who over-levered and over-built to supply that market (the export market from the US to SE Asia isn't actually that big; the reason the China issue is so painful to coal miners in the US is b/c companies built capacity, using debt, to meet this demand. It didn't materialize, and they're all overlevered and going bankrupt - I was reading some newspaper articles about PRB coal, and a professor from Montana noted that these companies wouldn't be in trouble if they hadn't overlevered) . Low nat gas prices have caused demand to shift from coal to nat gas, which has put alot of downward pressure on coal markets. On top of all of this, sovereign wealth funds and institutional investors are going on an environmental crusade and exiting their coal positions (forced selling).

 

Coal is not in secular decline, it is not a melting ice cube. There was too much supply, but it has come down considerably in the last couple of years, and will continue to decrease (even if people start building mines now, significant lag time between capex and the start of coal production). Now there is no demand, but the demand isn't gone, it has just substituted coal with nat gas, which will revert. Then, the US coal companies were over-levered...this is an easy fix, don't pick the over-levered ones (CLD and CNXC are good places to start). And then, finally, forced-selling: just understand that it is happening, that it is totally irrational, and stay out of its way. But also keep in mind that forced selling is probably contributing to some of these ridiculous market caps, and once the selling abates, you'll have a gem waitin' for you! PErsonally, I thought these companies were super cheap at 2-3x their current market caps, and they've continued to decrease. But, now we're below $100 million for CLD...not much further for it to fall (also note that CLD's core coal ops have an ebitda of like 170-180, but they have an export logistics business with take-or-pay contracts that was losing about 40 million/yr on the heels of China's slowdown, which they have sinced restructured with both the port and BNSF - this will remain an overhang, but the point is that headline EBITDA numbers understate it's core operations' earning power). And for CNXC, you are basically guaranteed the $2.05 for the next 2.75 years, which is close to $4 after-tax. With a current stock price of $6.63, ~2/3 of your investment comes back in cash over that time frame w/ no capital appreciation. if the stock price doesn't appreciate, still getting a pre-tax 30%+ div yield. If it does appreciate, that's upside (potentially hundreds of percents?). And, the stock could lose ~2/3 of its value in the next 3 years and you'll still break even. Remember, they wanted to price it at $20, so this bear case seems very unlikely, but even if I am totally wrong and that does happen, you're seriously protected on the downside with your div. income.