Hallador Energy Co (HNRG) 2021 Q1 法說會逐字稿

Good day, and welcome to the Hallador Energy Company First Quarter 2021 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Becky Palumbo. Please go ahead.

Thank you, Betsy. Yesterday afternoon, Hallador Energy released its first quarter 2021 financial and operating results on Form 10-Q and issued a press release containing certain financial metrics. Both documents are posted on our website. Today, we will discuss these results as well as our perspective on market conditions and outlook. Following our prepared remarks, we'll open the call up to your questions.

Before beginning, a reminder that some of our remarks today may include forward-looking statements that are subject to a variety of risks, uncertainties and assumptions contained in our filings from time to time with the SEC. While these forward-looking statements are based on information currently available to us, if one or more of these risks or uncertainties materialize or if our underlying assumptions prove incorrect, actual results may vary materially from those projected or expected. In providing these remarks, we have no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise unless required by law to do so.

Brent Bilsland, our President and CEO; and Larry Martin, our CFO, are on the call with us today. And with the required preliminaries out of the way, I'll now turn the call over to Larry.

Thank you, Becky. Good afternoon, everyone.

Before I get started, I'd like to define a couple of definitions for our items that I'm going to go over. We define free cash flow as net income plus deferred taxes, plus depreciation, depletion and amortization, changes in fair value of hedges and stock compensation, less maintenance CapEx and the effects of our equity method investments. We define adjusted EBITDA as EBITDA plus stock compensation and changes in fair value of hedges less the effects of our equity method investments.

So for the quarter, we had a net loss of $1 million or $0.03 a share. We generated free cash flow of $5.4 million. We had adjusted EBITDA of $11.4 million, and we decreased our bank debt by $1.7 million. Our bank debt at the end of the quarter was $136.1 million. Our net debt at the end of the quarter, $132.2 million, and our leverage ratio, which is debt to adjusted EBITDA, was 2.78x.

I will now turn the call over to Brent Bilsland, our CEO.

Hi, thank you all for joining.

During the quarter, our operations team performed exceptionally well. Production costs were significantly lower when compared to prior quarters. This increased productivity is yet to be turned into cash as shipments were interrupted due to the coldest February in 30 years. Though the cold weather has delayed our cash flow, it has led to continued improvement in market conditions, which allowed us during the quarter to increase our sales by roughly 400,000 tons for the year.

In Q1, production costs were $28.88 a ton, roughly $5 a ton lower than last quarter and significantly lower than Q1 2020 cost of $31.67. Looking just at Oaktown, this cost for $27.21 for Q1 '21 versus $29.92 for Q1 2020. Hallador's excellent operating results will be turned into cash soon as 180,000 tons of Q1 shipment delays will be delivered in the second and third quarter resulting in roughly $1.8 million of additional EBITDA for those quarters.

Total shipments for the quarter were 1.2 million tons. Though the cold weather did delay our cash flow, it led to multiple solicitations and additional sales. If market conditions continue to stay at this level or improve, we anticipate additional sales later this year. Increased productivity, coupled with shipments delay caused coal inventory to rise by $9.4 million. However, this coal inventory will be needed to meet increased shipments for the balance of the year.

Hallador was able to reduce bank debt by $1.7 million during the quarter and maintained $27,900,000 in liquidity despite the shipment delays. Our EBITDA ratio rose slightly to 2.78x at the end of the period. As we have discussed on past calls, Hallador expected its $10 million Paycheck Protection Program alone to be forgiven by the SBA this past April 8, as recommended by our bank. However, we're told the SBA is delayed in processing all claims, so we patiently await their response. Had the SBA forgiven our loan on the required April 8 date, our liquidity today would be roughly $41 million.

Looking forward, energy markets are recovering as evidenced by increasing gas prices. The NYMEX price, competitor coal averages $1.99 in 2020. That's the lowest average in over 2 decades. As of yesterday, the NYMEX 12-month gas strip was $2.99, so $1 increase. This is a price where Indiana coal plants, 77% of our customer base, are dispatching in front of gas plants. Coal export prices are also improving. API 4, which is the Asian market -- marker for Q3 2021, is at $86 a metric ton for 2021, third quarter. That's up 26% year-over-year. We also see the API2 marker in Europe for the third quarter of 2021 at $74 a metric ton, that's up 24% year-over-year.

As we look at the general economy, it seems likely it will be good for the foreseeable future. The Federal Reserve has indicated it plans to continue its policy of easy monetary policy, meaning it will do everything -- they will do everything in their power to keep interest rates low. Much like prior administrations, President Biden has announced his desire to continue providing unprecedented levels of financial stimulus.

Just to provide a little scale as to how big the U.S. fiscal stimulus is, MUFG reports the total U.S. fiscal stimulus announced, since COVID crisis accelerated 13 months ago, is now in excess of $10 trillion. Remarkably, this translates to just over 45% of U.S. GDP and over 35% of the $28 trillion of total U.S. gross debt outstanding. Though the growth in national debt scares me, the positive side of this equation is consumers have cash in their bank accounts.

Harvard Economist, Jason Furman, estimates that the combination of above-trend income and below-trend spending has created roughly $1.8 trillion of extra disposable income since the beginning of the pandemic. So it appears as if there's plenty of money to fuel the economy.

Howard Marks, who I believe is a fantastic investor and writer, points out in his latest newsletter, and I quote, "The biggest risk of all is the possibility of rising interest rates." Rates have declined quite steadily for the last 40 years. This has been a huge tailwind for investors since the declining rate environment lowers the demand return on assets -- lowers the demanded returns on assets making for higher asset prices. But the downtrend in rates is over, if we can believe the Fed's assurance that it won't take nominal rates into negative territory. Thus while interest rates can rise from here, implying higher demand and returns on everything, and that's lower asset prices, they can't decline. This creates a negatively asymmetrical proposition. So today's high asset prices may be justified at today's interest rates, but that's clearly a source of vulnerability if rates were to rise.

I would argue the opposite could be true today for fossil fuel energy companies. As the fossil fuel energy companies already have higher cost of capital as the market perceives the need for added risk premium. As the call for carbon-free electricity has increased over the last 4 years, politicians may have overpromised on the timing of what is practical to deliver. And as a result, Hallador went from trading at an enterprise value of 7.1x in 2017 EBITDA -- 7.1x EBITDA to trading at roughly half that multiple today. The question is, will the need for a risk premium increase or decrease from current levels over time, is Hallador more likely to return to multiples of 7x or drop to multiple of 2x over the next few years.

President Biden says carbon-free electricity by 2035 is our goal. And it's an admirable goal. However, we find the electric grid operators and the utility CEOs are more tempered in their statements. MISO says 40%, and MISO is the grid operator for the Midwest. So 40% renewables might be possible, but they neglect to say by when. During February is extremely cold weather for several days, MISO's generation was approaching 60% coal-fired power. So that's roughly 60 days ago, MISO's grid was roughly 60% coal-fired power. That figure does not even include other types of fossil fuel plants that were also running at that time.

If we look at January and February of 2021, MISO has averaged 46% coal and 24% gas generation, meaning 70% of MISO's generation was powered by fossil fuels during the January-February time period, was the last reporting period. I ask the question, is it likely that MISO will replace 70% of its 2021 generation in just 14 years?

Duke, Indiana -- or Duke Energy, Indiana's largest coal consumer, has a net zero target of 2050. That's 29 years from now. Last month, Indiana's Governor signed a bill enabling the Indiana Utility Regulatory Commission to take into consideration federal phase-out requirements, i.e., carbon-free electricity by 2035, of a particular energy resource and adjust depreciation rates of new planned future generation sources -- resources in a manner that is best interest of the ratepayers. This bill potentially requires utilities who desire to build a new gas plant to shorten their depreciation schedules from 30 years to something much less.

On April 22, Nick Akins, AEP's Chairman and CEO, said Indiana Michigan Power and AEP Generating Company have reached an agreement to acquire the 1,300 megawatt Rockport Plant unit number 2 from the current owners when the lease expires at the end of '22. This has significant -- this has the significance of extending the life of a coal unit. This acquisition will provide a short-term capacity bridge for customers, as they transition to more renewable generation and will assure that both Rockport units are retired by the end of 2028. These investments, and I'm quoting Akins here, "In our generation portfolio, support our goal of making our generation fleet cleaner, more economical and achieving net-zero carbon dioxide emissions by 2050." Again, note the reference to 2050.

But also of importance here is this is a case in Indiana, where coal unit had been announced for closure in 2022 and to be replaced with a new natural gas plant, but the utility has now decided to extend the life of the coal unit and utilize the existing asset to bridge to the greener future. What might the value of co-equities do if this trend of using coal to bridge to renewables catches on? Is this concept priced into the market today? Could the future of coal be dramatically changed if there is successful penetration of carbon capture and storage technology? Tax credits for both carbon capture and storage have been increasing. Today, there are bills in both the House and the Senate that would further expand the 45Q tax credits, both in size and duration.

At least 10 utilities are considering carbon capture projects at coal plants here in the U.S. Carbon capture was embraced by candidate Biden and is expected to be a component of President Biden's compliance plan. Carbon capture has domestic appeal because it allows the continued use of produced fossil fuels. It also has enormous international appeal in countries currently depending on coal generation. I would also add that most fuel energy companies are working on some sort of business pivot. We see some coal mining companies divesting a steam coal assets and increasing their metallurgical exposure. Others are focusing on owning reserves of renewable elements. Others may focus their attention on developing solar projects while helping their customers transition to greener electron. Some are just focusing on generating cash for as long as they can.

So there are 2 questions investors in this space, I think, must ask. How long will the transition take? And which companies have the management teams that will make the transition? I think it is unlikely that an electric system that took well over 100 years to develop can be replaced in 14. I also believe our customers' desire to transition with the help of a familiar face, and Hallador is working every day to try to be a partner -- to be that partner for our customers. In both cases, a longer transition period and/or a successful pivot of the company, risk premiums will fall and valuations will rise. Time will tell what Hallador investors think is most likely to happen.

So with that, I will open up to questions from the audience.

(Operator Instructions) Our first question comes from Lucas Pipes with B. Riley Securities.

And Brent, thank you very much for your very interesting comments just now. I first wanted to ask a little bit about the current market environment. You mentioned strengthening prices internationally, domestically. But I wondered if you could maybe hone in a little bit on the Illinois Basin of what you're seeing there specifically? Are -- where would you put pricing for average products today? And what sort of term business might be available? Would appreciate your thoughts on that.

Well, today, as far as term goes, we've seen -- if you kind of look back last year, energy demand was way down, the struggling economy with the COVID pandemic. But yet most utilities had more coal bought than they needed. And so everyone kind of went in the last winter pretty long in their positions. October was -- the demand, November was terrible; December, January were good; and February was fantastic from a demand perspective. So we've seen coal inventories kind of come back into alignment to -- everyone is starting to look at much more comfortable levels.

I think that on one hand, utilities are looking at -- it's been long and wrong over the last several years, and they've taken some heat over that at their various regulatory committees. So they've had a desire to stay shorter when gas prices popped here in the last month. I think that made them all say demand is better than we thought and we need to run out and buy some coal. We're expecting to see that, as I said it in the comments, that if the market stays this strong or better, I expect to see more buying in the back half of the year. So all that's kind of playing out like we thought. But as -- we see big open positions in our customers' portfolio starting next year.

So we really think business for us is better next year than this year. We're starting the better -- the year off in a little better hedge position. And just from talking to customers, they have bigger open positions. And I think they're also grappling with -- as the market has consolidated, in some cases mergers, but in other cases just suppliers went away. I think you're going to see a return to utilities tying up for longer periods of time because they want to make sure that, "Hey, it's one thing to have a plant that's going to run for the next 10, 15 years." They want to make sure they've got a supplier to work with for the next 10, 15 years, and that list is getting shorter. So for now, because we've had such extreme changes in coal inventories in 2021 from going from very high inventory levels to February from a demand perspective kind of got things back in line, I think they're trying to make sure that demand recovery has happened. And they'll just keep filling in with spot. But it does feel like to me we are seeing conversations that are much longer-term in nature that are being originated by the utilities.

Very, very helpful. And then you touched on a couple of really interesting points in your prepared remarks. And specifically around the kind of tying the rising interest rate environment to valuations in the coal and E&P sectors. Brent, I want to follow on these steps a little bit and ask you if we are in a rising interest rate environment, what are the implications for this renewable energy transition directly? Obviously it makes capital more expensive, but would appreciate your thoughts on that.

Well, I think that it definitely raises the cost of any new construction, right? So the higher capital cost, all this new generation is going to have to be paid for potentially with rising interest rates. Certainly, the Fed is doing everything in its power to keep interest at or near 0, very low. But the question becomes is if we start to see inflation, are people going to buy 10-year treasuries at 1.5% yield if we have 3% inflation? So can the Fed keep interest rates low forever? I don't know the answer to that. I think that there's far less risk for that in the coal space because if you look at the coal group, it already has high interest rates. I mean, if you look at the coal spaces' bonds, they're trading anywhere from 7% to 36%, depending on who the group is.

And to me, especially as we start to see a return to longer-term coal supply contracts and I think as time goes on, it will become more evident that we're not going to be carbon-free electricity by 2035. It's going to be something longer like 2050, like all the utilities are signaling, right? It's just too complex. If we want green energy part of the time, then it can be done. It's 24/7 and the resiliency that we want when it's cold in Texas and nobody was expecting it. That's where it becomes really difficult. So I think that higher interest rates, I think, it will affect renewables that have yet to be built. It will just make their cost profile go up.

Now if people still want to pay that -- for that, it will work, right? It's just a matter of cost, what will people pay. So that's -- but I think the transition and the point of all my comments really were twofold. One is this transition is going to take much longer than people think. And because of that, there's going to come a point in time where this risk premium that people are putting on the coal space, I think, has a potential to alleviate, right? We traded at 7x -- our enterprise value was 7x EBITDA 4 years ago. But what's really changed? What's changed is the perception of risk. But as you look at our business, one thing that is valuable to it is long-term contracts, right? So as we see a return to the long-term contracts, I think that the risk premium could start to alleviate. So we'll see.

I also think that -- I mean, I know most of the CEOs of all these different companies, and they all -- how they're signaling in their public calls. They're trying to figure out, "Hey, if our customers want to make a change, great. Then we've got to figure out how to meet their goals and their needs." And we have decade -- multiple decade-long relationships with 19 different utilities and industrial customers here in the U.S. So I think those people do want a transition. Everyone has a different timing for that transition. But I think, by and large, those customers are signaling to us, they want to do that with a familiar face. Can we help them?

And that's also part of the reason in those discussions that we think this transition period is much longer than what the press might have you to believe. So for both of those 2 reasons, when I look at us and I look even at our competitors, I think the opportunity for all of these energy companies to trade at a higher multiple is greater than its probability of trading at a lower multiple in the future.

Very helpful. And last one for me. You mentioned inflation earlier. Are you seeing inflationary pressures? If so, where? I'd assume roof bolts are getting more expensive labor type. We had some comments from some of your peers this earnings season that were pretty interesting along those lines, so would be curious to hear what you're seeing on the ground today.

Well, I -- yes, I'd like -- roof bolts -- definitely yes, steel prices are up, roof bolts are costing more, bits are costing more. We were able to get our costs down significantly for the quarter. So kudos to our production team for that. Labor, I think that to date we've been able to find good people to do the work and retain those people. Our jobs are typically the highest paying in the counties that we're in. So, so far, so good. I'm not saying that we're not -- could labor become an inflationary issue down the road, it certainly could. And we just haven't -- we haven't experienced that quite yet.

(Operator Instructions) Our next question comes from Rob Lietzow with Lakeway Capital.

So you guys used to pay a dividend. And obviously, things changed. You took the dividend away. When might that be something you would be considering putting back in, obviously, that would probably help your stock price as well?

Yes. I think that when our company gets under 2x debt to EBITDA, we'll consider it. But prior to that, it's unlikely. Our first goal is to preserve our balance sheet so that we can make the necessary changes that we see coming down the road. And that might mean investments in slightly different types of assets than we've invested in the past. And so we're just really trying to keep our balance sheet to where we can be in a position to take advantage of that. I mean, there's -- the grid is in a period of transition. I think that's going to take decades, not a couple of years. But still, when we think about the grid, it's fairly rapid change, right? It took 100 years to build. It's going to take 20-something to change. And that creates a lot of opportunities for us, right? Our goal is to solve the problems of our customers and the best that we can and help them solve their problems. And so all that's a really long way of saying we probably won't pay a dividend until we're under 2x debt to EBITDA.

Okay. That's fair enough. I think you're not that far away from that, it's the way you're generating cash right now. So seems reasonable.

(Operator Instructions) With no other questions, this concludes our question-and-answer session. I would like to turn the conference back over to Brent Bilsland for any closing remarks.

I want to thank everyone for taking the time today to listen to our call and their continued interest in Hallador Energy. Thank you very much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.