SunCoke Energy Inc (SXC) 2015 Q1 法說會逐字稿

Welcome to the SXC earnings call. My name is Cynthia and I will be your operator for today's call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to your host, Lisa Ciota. Ms. Ciota, you may begin.

Thank you, Cynthia. Good morning, everyone. Thank you for joining us on the SunCoke Energy first-quarter 2015 earnings conference call. With me are Fritz Henderson, our Chairman and Chief Executive Officer; and Fay West, our Senior Vice President and Chief Financial Officer. Following our remarks made by management today, the call will be open for Q&A. This conference call is being webcast live on the Investor Relations section of SunCoke.com, and a replay will be available for a few weeks. If we don't get to your questions on the call today, please feel free to give me a call later this afternoon at 630-824-1907.

Now before I turn the call over to Fritz, let me remind you that the various remarks we make on today's call about future expectations constitute forward-looking statements. And the cautionary language regarding forward-looking statements in our SEC filings apply to our remarks today. These documents are available on our website as are reconciliations to any non-GAAP measures discussed on today's call.

Now, I will turn the call over to Fritz.

Thank you, Lisa. Good morning, everyone. Page 2 is a quick summary of the quarter. The quarter for SunCoke Energy was a solid one both from a safety, environmental, and operating and financial perspective, a good start to the year for us. And Fay will have a chance to go through the normal variances, but as we look at it, a good, solid start to the year for SunCoke Energy. I'll come back and talk about some pluses and minuses but we were pleased to see that.

We did increase our quarterly dividend earlier this week by 28% on SunCoke Energy shares, in line with the increased distributions we are receiving from SXCP, our investment in our limited partnership, SunCoke Energy Partners. We do as a parent continue to maintain flexibility to both support growth, importantly, and return additional capital to shareholders. I'll have more to say about that later in the presentation.

We continue to work the pipeline of long-term growth opportunities in a number of industrial facing verticals. And finally, based upon the performance we had in the first quarter and our expectations as we are in April and through the rest of the year, we have recently affirmed our 2015 consolidated adjusted EBITDA guidance, reflecting both the operating performance of our plants and the strength of our long-term take-or-pay coke-making contracts.

At this point, I will turn it over to Fay.

Thank you, Fritz. As was just mentioned, the first quarter of 2015 proved to be a solid quarter across our businesses. Adjusted EBITDA from continuing operations for the first quarter was $49.1 million and was up approximately $10 million or 24% from the prior-year quarter. As you can see in the chart, this increase is based on better performance both at our coke operations and at our coal logistics operations. Corporate costs were also lower as compared to the prior year. And we walk through the changes in adjusted EBITDA in greater detail on the next slide.

Moving on to EPS, in the first quarter of 2015 we reported an EPS loss of $0.03. The current period includes transaction and financing costs related to the Granite City drop-down, which occurred in January 2015. EPS excluding the impact of these financing and transaction costs was income of $0.06 per share. Finally, we are reaffirming our full-year consolidated adjusted EBITDA guidance of $190 million to $210 million.

Turning to slide 4 and drilling further into the first-quarter results, working from left to right on the chart, we identify the drivers of the year-over-year increases in adjusted EBITDA from continuing operations. We saw year-over-year improvement in our domestic coke operations, most significantly in our Indiana Harbor facility, where coal-to-coke yields and sales volumes were up meaningfully. As you may recall, our 2014 performance across the slate was impacted by severe weather conditions. And while we did experience the coldest February on record at our Indiana Harbor facility this year, the impact of weather was not as significant in the current year.

Overall, the absolute spend for operating and maintenance activities at our domestic coke operations was unfavorably impacted by year-over-year by the resetting of Indiana Harbor's cost pass-through mechanism. This contractual resetting occurred in January 2015. And while this is an unfavorable lap to the prior year, the impact was considered and included in our 2015 adjusted EBITDA guidance. Additionally, Brazil volumes were up significantly over the prior year, well over 70%, resulting in an increase in adjusted EBITDA.

As you can see in the chart, corporate costs were lower in 2015, and as the prior year included the impact of corporate restructuring charges. This brings us to adjusted EBITDA from continuing operations of $49.1 million, a $9.6 million increase over the prior-year period. Working from continuing operations to consolidated operations, legacy items contributed about $2 million in income in the quarter. These results were aided by a $4 million OPEC curtailment gain related to the downsizing of our coal mining operations. Once again this impact was considered and included in our 2015 adjusted EBITDA guidance.

Discontinued operations came in at a loss of $3.1 million in the quarter. We are pleased with the progress in implementation of our coal rationalization plan, and we are well within the previously communicated adjusted EBITDA guidance for discontinued operations. In total, our consolidated adjusted EBITDA for the first quarter was $47.9 million, up from the prior-year quarter of $33.6 million.

Moving to slide 5, the domestic coke fleet continue to deliver stable results in the first quarter. Adjusted EBITDA per ton was $56 for the quarter and was within our guidance range of $55 to $60 per ton. This was also a significant improvement over the prior-year quarter. Our recovery at Indiana Harbor continues to be a bit more challenging than we expected and this resulted in us lowering the full-year production outlook to 1.1 million tons for this facility. But our full-year production guidance for the entire coke slate remains unchanged at 4.3 million tons. Despite these first-quarter challenges, we continue to have confidence in the performance of our domestic coke fleet, which supports the reaffirmation of our full-year consolidated adjusted EBITDA guidance. And as you can see on the next slide, we ended the quarter with total cash of approximately $165 million. This was up more than $25 million versus the fourth quarter of 2014.

Positive cash flow from operations was offset by CapEx of $8.3 million and cash used in discontinued operations of $15.5 million. This amount included severance payments that were accrued for in 2014 and other working capital changes in the discontinued operations. As you can see, we had a cash outlay of approximately $24 million related to, one, the $20 million ASR that was executed in the first quarter; and, two, approximately $4 million in dividend payments. These amounts were more than offset by proceeds related to our Granite City drop-down. With revolver capacity of nearly $400 million and approximately $165 million in combined cash, we are well positioned to pursue growth opportunities and to return capital to shareholders. And on that front we amended our revolver, specifically the restricted payment basket capacity, to allow for increased flexibility to return capital to shareholders via share repurchases or dividends. This is a first step as we transition to a more traditional GP structure.

Now, I will turn it back over to Fritz.

Thanks, Fay. Next charts steps back and looks at the investment pieces behind SunCoke Energy. We do believe we are well positioned to deliver long-term shareholder returns. The business starts with our operating model and business model. Plants that run well generate stable, sustainable cash flows. The contracts themselves are long-term take-or-pay contracts with minimal commodity risk to provide results which are stable and are not cyclical and do not move with commodity prices. Our balance sheet itself at the parent and at the MLP is conservatively levered with considerable liquidity, which provides us financial flexibility to both support growth, whether it's done at the partnership or in the event that the parent needs to invest alongside the partnership in order to do a larger transaction, we have the flexibility to do that, and return capital to shareholders, both what we have announced today as well as what we were doing the future.

Finally, in terms of growth opportunities, we do anticipate executing at least one additional drop-down in 2015. We are working -- and I will talk about this later. We are working on the drop-down of 23% of Granite City in the second quarter. But, most importantly, we are building a robust pipeline of long-term growth targets, which is for us the highest priority in terms of growth.

Finally, in terms of return to shareholders, we have returned $110 million to shareholders in the last 12 months at the SXC level. And we anticipate -- this is a little over 10% of our market cap, and we do anticipate the ability to continue to increase dividends going forward. And I'll talk about this relative to drop-downs, but I think it's very important that we can do this whether or not we accelerate or whether or not we are patient in our drop-down strategy. And I want to come back to this on a later chart.

To the business model -- the business model is summarized on page 9. All of our contracts have similar characteristics in terms of the contract provisions, obviously the long-term take-or-pay, minimal commodity risk. The provisions are summarized here on the chart. For those of you who have been with us and followed us since we went public in 2011, no change in this chart.

But what does it really provide us? Well, it provides us with the business that involves the customer's obligation to take all the coke we produce up to a contract maximum. These are long-term take-or-pay agreements which provide stable cash flows during market upturns and during market downturns. We don't participate in upturns in the market. Therefore -- and at the same time we don't suffer cyclical downturns in our business. That's not the way the business is structured. Commodity risk is minimized through the pass-through provisions. No early termination contracts through default. We have one contract that does have an early termination provision which we talked about extensively in the past. And it involves a contract with AK Steel at Haverhill 2, where we supply a critical blast furnace for AK Steel in Ashland. So it is an asset that we think is strategic for our customer and it's the only such contract we have within our portfolio.

Finally, our counterparty risk is mitigated in a couple of ways. One, we supply strategic blast furnaces for our customers. And our customers' obligations themselves are to the parent Company. So our business model is focused on generating stable, sustainable long-term cash flows, which was the origin for thinking about why this was appropriately placed in an MLP. The basics of the business involve the stability. They don't involve growth but they are stable. And they provide us an ability to both support growth as well as distribute cash to our shareholders.

I'll stop here for a second and mention that the Granite City contract that we have -- and I'll take questions on this later -- is the same framework. And as we look at our production today, we are basically operating our Granite City plant business as usual today.

Page 10 -- we do maintain the flexibility to fund growth. We have multiple levers at both the parent and MLP to facilitate both drop-downs and, importantly, to fund growth opportunities. Fay mentioned that amendment that we recently received with good support from our banking group at SXC, which is really focused around restricted payment flexibility. We also received an amendment from SXCP lenders which allowed us basically another half a point a turn of leverage capacity so that we could run the MLP at a level 3 1/2 to 4 times debt to EBITDA, which is about a half turn wider from what our historical target has been. But if you look at it, it's a level we are quite comfortable with relative to how we operate the MLP. We have $165 million of combined cash. We have a $400 million of combined unused revolver. So we believe from a financing flexibility perspective we have the ability to compete for and execute either transformative or bolt-on acquisitions.

As we think about the M&A pipeline, it starts with what are the guard rails, what are the criteria we use? One, strategic fit -- it needs to -- as we think about leveraging core competency, we are manufacturing company, a processing firm. And we think that that core competency is something that is important as we look at acquisition opportunities. The financial fit is important to us -- stable cash flows, limited commodity risks, and qualifying income. That doesn't mean you don't look at businesses. You have to look at businesses that have zero commodity risk. But it needs to be limited, similar to what we have -- we have an MLP which is focused around stable cash flows with reasonable coverage, actually quite conservative coverage even at 1.1. We think businesses, as we look at opportunities going forward, need to be consistent with the mission of the MLP in the coverage ratios and how we think about the MLP as a stable business.

And finally, it needs to be actionable. We need to be able to compete, to acquire the business. Therefore, it needs to be appropriately sized.

The verticals are summarized at the bottom of this chart. We have reviewed this with a number of investors over the last four to five months. This is a portfolio of verticals that we have been working for the last three or four months and we continue to pursue these. We will be disciplined in terms of mergers and acquisitions. I think it's important to do so if you think about discipline in terms of being, one, obviously, meeting the guard rails; but, two, meaning the financial hurdles. You want a transaction that's accretive for the MLP and that creates value for SXC. So, I think having the appropriate financial discipline and the patience to use that is an important criteria. This is something we're working on with a high sense of urgency.

On capital allocation, summarized in the next page, on the right-hand side of the page is SunCoke Energy Partners. It's pretty straightforward. We want to maintain leverage capacity and financial flexibility in order to pursue long-term growth. At the same time, we just recently declared our eighth consecutive per-unit distribution increase. We have adjusted our coverage ratio in light of the asset performance and the seasoning of our MLP. We think it's at a level, particularly with replacement accrual we make within the MLP, that we can both pursue growth as well as increase distributions going forward. And in fact, we are ahead of schedule relative to the three-year plan we outlined when we originally indicated that we planned to drop all of our assets into the MLP, all of our coke-making assets into the MLP.

Looking at the parent or SunCoke Energy, we intend to preserve our leverage capacity to support long-term growth. This is very important. As we think about the parent, the parent -- we can see transactions and have looked at transactions where the parent is investing alongside SunCoke Energy Partners in assets which would generate qualifying income and ultimately would be dropped down into the MLP. We think it's important that the parent have the capability to do that with the MLP. But at the same time we have the flexibility to return capital to shareholders. We have increased -- we just recently, this week, increased our dividend by 28%. We plan to, as we grow distribution in the MLP as well as, as the assets that are sitting upstairs are themselves generating cash flows, we think we have the flexibility to return a significant portion of free cash flow to the SXC investor going forward. And our intent is, beyond the free cash flows of the business, that we can return excess cash that could be generated as a result of a drop-down transaction, for example, to shareholders via either share repurchase or via special dividend. That would be something that would be considered when we did the drop-down transaction.

The pathway in terms of timing is summarized on the next page. To the left of the completed activities. I've touched on a number of these already, so I'm not going to belabor them. But I think an important point, to Fay's point, one of the two things, as we talked about, having a GP with more flexibility in terms of returning capital to shareholders that we felt were important we needed to get done. One was to amend our credit facilities to provide an appropriate amount of flexibility, which we've done so and closed that this week. And the second is ultimately to redeem the bonds that exist at the parent. And our plan would be, with the drop-down of Granite City's 23% interest, that we will have an opportunity to do that. And our target to do that is in the second quarter.

At the same time, once you do that we could then approach the SXC board with respect to seeking additional share repurchase authorization. So this is how we think about sequencing and timing. And beyond the second quarter, our plan is to complete the remaining drop-downs. We will have Jewell and Brazil Coke ready in the second half of 2015. Indiana Harbor as a practical matter is something that we would look at in 2016. We want two consecutive quarters of stable operations from our Indiana Harbor operation before we consider dropping that into the MLP.

I want to make a point here. We have estimated what the proceeds would be from executing our drop-down transactions on a reasonable set of assumptions. And that resulted in a $350 million to $400 million of cash that would be generated at the parent after paying down debt and after paying the appropriate taxes. One of the things that's important to understand is that we will take into account market conditions as we execute our drop-down transactions.

A drop-down transaction needs to be value creating for both the SXCP unit holder but also for the SXC investor. One of the advantages of being ahead of the schedule in terms of our drop-down plan is that if we don't find the market conditions favorable for both sets of shareholders, we will be patient. And so, market conditions are important to us.

I've been asked for specificity around dates and times. As I said, we will be ready in the second half with respect to both Jewell and Brazil, but we will also evaluate market conditions at the time. If the market conditions don't allow for a transaction that's attractive for both sets of shareholders, we will be patient.

That patience, however, doesn't from our perspective limit our ability to look at additional capital steps that we can take with the SXC shareholder. The assets themselves, which will be dropped down, particularly the Jewell asset, is already generating cash flow upstairs at the parent. The Indiana Harbor plant as it reaches its goals will also generate cash flows. And so as the cash flows are at the parent, that provides the capability for us to look at increases in distributions, irrespective of when we would execute the specific drop-down transactions at the parent level.

Summarizing and finalizing, on page 14 the investment thesis to SunCoke Energy -- we think we are well positioned to deliver long-term shareholder returns. We have a business model that's focused around coke plants that generates stable cash flows. Our coal logistics business also does not have the same long-term contract, but it has sticky contract and it doesn't involve commodity risks. We have a strong balance sheet both at the MLP as well as at the parent that allows us to both pursue growth opportunities as well as return cash to shareholders.

So with that, let's open it up for questions. Thank you very much.

(Operator Instructions) Paul Luther, Bank of America Merrill Lynch.

First, I was wondering if you could just provide a little more color just with respect to the future drop-downs and how the leverage at SXC impacts that decision because I know that at SXC you reported total debt of about $100 million. And I just want to get a sense for what that means for the potential returns out of further drop-downs if the amount of debt that you have to exchange at the LP, how that affects the decisions.

So we have $105 million of bonds remaining at the parent. With the next drop-down transaction we would anticipate, assuming it's the Granite City 23%, you would have a portion of those bonds called, as we've done in prior drop-downs. What we could very well do is call all the bonds, though. We could actually use cash at the parent or more likely use some revolver capacity at the parent to call the remaining bonds. Once we do that, I'll call it, the basket provisions are in the bonds, the bonds are extinguished. So that's how we would think about the $105 million of bonds that are sitting remaining upstairs at the parent.

Okay. Can you talk a little bit more about Indiana Harbor and progress with respect to the output there, if you have any better sense of when you might hit those kind of stable consecutive quarters?

So let's start with the fact that it's behind where we wanted it to be, while the -- what we saw, we saw improvement in the first quarter. But it was obviously not what we are looking for relative to production. This was -- as we thought about the first quarter performance, Indiana Harbor was negatively affected by a number of factors. Actually, most notably, we came into the first quarter from the fourth quarter of last year not running at the levels we wanted to be. And then, frankly, this was -- it was a difficult winter for Indiana Harbor. It was very cold, which affected the ovens and the ovens' performance.

So we were up year over year but not where we wanted to be. As we look into the second quarter, while we are disappointed so far -- disappointed through March, I should say -- what have we seen? We've seen better oven performance. We've seen better mechanical availability and reliability. We've seen the asset itself perform significantly better from an environmental perspective, from a safety perspective. Ovens per day is improving. Oven temperatures are improving. We see a lot of good leading indicators. So as we think about Indiana Harbor, it has taken us longer to achieve the goals than we want. I wouldn't call the second quarter -- I don't think the second quarter is going to be indicative of what the run rate should be for Indiana Harbor. I think as we get to the second half of the year we feel good about the run rate at Indiana Harbor. But what that would say is that if we actually ran in the third and the fourth quarter the way we expect to run, that we really would not consider that to be a drop-down until early next year. So that's how I'd try to respond to your question.

Thanks, that's helpful. And then finally I'll ask just about coal logistics and the outlook there. I think previously you had guided to EBITDA of $17 million. I think that was mentioned on the last call. Just looking at Q1, it was a little bit below what a run rate would be. I didn't know if that was just seasonality and weather impact. I just wanted to check in on that business, too.

They were impacted in the first quarter by weather, and specifically some flooding that impacted their operations as well. They were better than the prior-year quarter, primarily because they had some -- they really did a nice job of managing their overall operating costs and had some sales mix favorability versus the last year. At this point we are still intending -- our full-year guidance remains unchanged for coal logistics.

Okay, great. Thanks, Fritz and Fay.

So Lisa advises me that there are no other questions.

If anybody wants to queue up for a question, please do so. Otherwise, we will conclude the call.

Yes, I'll give it a minute here.

(Operator Instructions) Paul Luther of Bank of America Merrill Lynch.

I figured I'd continue. I had another one, just -- I appreciate the color you gave on cash return. I was wondering how you think about dividends versus buybacks, given where the stock is. I think you have $55 million left of authorization. In terms of dividends I believe you pegged it against the LP and GP cash flows from partners. Would you look to change that ratio? Just wondered if you could add a little more color on those things.

Paul, thank you very much for asking a question. I'm told -- Lisa actually advises me that the queue has got another one behind it, so that's good. Otherwise you would have been the only person to ask me a question all morning.

I'd say a couple things. First, we did have $55 million left on the repurchase authorization. We wouldn't ask to refresh that, for example, until we actually called the bonds because we need to do that. We need to kind of go through the steps. From my perspective I think there's a role to be played in both share repurchase as well as dividends and that capital allocation strategy. We have pegged the SXC dividend at 33% of the SXCP from the cash flows that the parent receives from SXCP, both GP and LP cash flows. Obviously, this is a subject for board consideration. But as we think about it, we are not wedded to the 33%. We have flexibility beyond that. And as I think about the parent and the cash that's generated at the parent, even pre- the drop-down transaction -- this is why I spent some time on that chart -- we have flexibility to increased dividends above where we are today. Obviously, it's a subject that's got to be approved by the Board. I think there is a role to be played in the capital allocation framework for both share repurchases as well as dividends. And we've done both, thankfully.

I would say -- I guess the last point I would make on this subject is the leverage capacity at the parent -- the parent, particularly when the assets are upstairs, does -- it's basically unlevered in terms of net cash. Our approach is to preserve that leverage capacity to support growth. But the business itself generates cash. So it gives us the ability to both repurchase shares and pay an increased dividend without having to use leverage.

Got it. That's helpful. Thanks again, Fritz.

Dean Graves with Eaton Vance.

Fritz, I wondered if you could first talk to us a little bit about the change in leverage target at SXCP. It's up a half a turn to 3 1/2 to 4, and what you guys' thought losses was around that and why that was a level and maybe not even a higher level, for example.

And then the second question, unrelated -- can you guys review for us the reset of the cost pass-through mechanism at Indiana Harbor and why that was the case and what that means from a cost perspective?

Okay. When we developed our 3 to 3 1/2 originally, obviously we had a new MLP, a new nontraditional MLP in a different space. We thought it was a conservative level of leverage. What the rating agencies have indicated is below 4 is where they see us relative to our existing rating. And so as we have matured and as, I think, we have demonstrated performance, we felt like 3 1/2 to 4 was a reasonable level to move to, one that would preserve existing ratings, one that would allow us to run the business and provide us a little bit more flexibility to support growth. And so that's the quick answer to the 3 1/2 to 4.

I think your question, is it meaningfully above four -- I don't really think it's warranted. And moreover, I'm reasonably confident it could attract negative rating action. Our credit agreements typically allow us half a point of flex in the event of an acquisition, which we would -- I think it's six months. So, we have some flexibility even within existing credit agreements. We have not used it and we wouldn't anticipate using it unless we had something that was -- unless we had something that was highly attractive and we felt like we needed to do that. So I think it's prudent, Dean. And that's why we landed there.

Relative to the pass-through mechanism, this is something that we've communicated when we talked about the Indiana Harbor contract renewal. When we set our guidance for this year we factored that in and actually communicated this late last year, that this was going to be a headwind that we were going to face relative to the Indiana Harbor results. And what we did was when negotiated the renewal with ArcelorMittal in 2013, it involved a number of revisions. It involved a higher fixed fee, it involved -- but what it involved from a cost standpoint was we did cost-sharing in terms of -- for costs above budget. There are individual subcategories, by the way. But in effect, through the end of 2014 we were working with ArcelorMittal on more of a sharing basis. We did a budget. We would share overruns basically 50-50.

When we got to 1/1 of 2015 we go to a fixed number. Again, there are individual subcategories that could involve some indexation. But, in effect, we are basically fixed in our O&M number for the next three years. And after that I think we and ArcelorMittal then sit down again and consider what the budgeted levels of cost are at the plant. So this is something that we've known. It was something that was part of the deal and it was factored in when we set our guidance for 2015.

So as a follow-up to your comment on the amendment to the leverage covenant, you mentioned you could possibly exceed it for 6 months. Does that mean you could exceed now the foreign half pounds 4 1/2 times for six months?

Yes.

Yes? Okay.

It's basically -- think of it as -- we think of it as basically something that you use in the event you have a single transaction and we have a clear guide path to come back under that number. We think 3 1/2 to 4 is the right place to be.

Okay. Thanks, Fritz.

(Operator Instructions) Garrett Nelson with BB&T Capital Markets.

Sorry for the lack of questions. It's kind of a busy earnings day. But a great release and it's good to see that a lot of the fears that are out there are overblown. Has US Steel given you any indication as to how long they think Granite City will be idled? And sorry if I missed it earlier. But where is that coke -- where are they shipping that coke from your Granite City coke ovens?

So, Garrett, no need for apologies. Thank you for asking a question. I would say couple things. Your question on where we are shipping it -- interestingly, we are not shipping it anywhere. They are running one of the two blast furnaces today. So we are -- and their coke plant shut down some time ago. So we are basically supplying the blast furnace that's there. There's some inventory that we worked with US Steel to locate places to put inventory. And frankly, it's business as usual today.

And then on your first question, no, they have not indicated -- what they said publicly is that outage would continue and they would come back into production based upon market conditions. They have not provided us any other color on that.

Great. Okay, thanks.

Okay. So there aren't any other questions. Again, I want to thank all of you on the call. I know it is a busy day, actually, for you and for us. But appreciate very much your interest in SunCoke, your investment in SunCoke, and look forward to talking with you on an ongoing basis going forward. Thanks very much.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.