Alliance Resource Partners LP Q2 FY2022 Earnings Call

Greetings. Welcome to Alliance Resource Partners Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the program over to Brian Cantrell, Senior Vice President and CFO. Thank you. You may begin.

Thank you, Sherry, and welcome, everyone. Earlier this morning, Alliance Resource Partners released its second quarter 2022 financial and operating results, and we’ll now discuss these results as well as our perspective on market conditions and outlook. Following our prepared remarks, we’ll open the call to your questions. Before we begin, a reminder that some of our remarks today may include forward-looking statements, subject to a variety of risks, uncertainties, and assumptions that are contained in our filings from time-to-time with the Securities and Exchange Commission, and are also reflected in this morning’s press release. 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, our actual results may vary materially from those we projected or expected. In providing these remarks, the partnership has no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, unless required by law to do so. Finally, we’ll also be discussing certain non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures are contained at the end of ARLP’s press release, which has been posted on our website and furnished to the SEC on Form 8-K. With the required preliminaries out of the way, I’ll begin with a review of our results for the quarter and then turn the call over to Joe Craft, our Chairman, President, and Chief Executive Officer, for his comments. As we reported earlier this morning, Alliance delivered strong results during the 2022 quarter, posting increases to all of our key operating and financial metrics, compared to the 2021 quarter, reflecting improved performance for both our coal operations and our royalty segment. ARLP’s coal sales and production volumes increased 13.9% and 18.7%, respectively, while our royalty sales volumes for oil & gas and coal rose 27.6% and 11.9%, respectively, all as compared to the 2021 quarter. Price realizations also increased across the board during the 2022 quarter with coal sales price per ton, increasing 43.3%, oil and gas prices jumping 64.7% per BOE and coal royalty revenue climbing 11.3% per ton. Driven by increased sales volumes and higher prices, ARLP’s total revenues for the 2022 quarter increased 70.1% to a record $616.5 million, as compared to the 2021 quarter. Net income and EBITDA also jumped significantly during the 2022 quarter, increasing 266.7% to $161.5 million and 105.6% to $243.8 million, respectively, over the 2021 quarter. Our financial results also improved over the sequential quarter, as total revenues increased 33.8%, income before income taxes jumped 111.1% and EBITDA rose 60.1%. ARLP generated $83.5 million of free cash flow in the 2022 quarter, an increase of 5.1% and 179.3% compared to the 2021 and sequential quarters, respectively. During the 2022 quarter, we returned $45.8 million to unitholders through our quarterly distribution, reduced our total leverage ratio by 19.5% to 0.66 times trailing adjusted EBITDA. We increased working capital by 30.5%, invested $52.7 million in previously announced energy transition and infrastructure growth opportunities, and we ended the quarter with liquidity of $572.3 million. Turning from our consolidated results, let’s now take a closer look at the performance of ARLP’s business segments during the 2022 quarter. At our coal operations, the previously mentioned increases to coal sales volumes and pricing led coal sales revenue higher to $531.8 million, an increase of 63.1% and 36.9% compared to the 2021 and sequential quarter, respectively. Segment adjusted EBITDA expense per ton increased compared to both the 2021 and sequential quarters, reflecting higher labor-related expenses, inflationary pressures and supply chain issues on numerous expense items, increased sales-related expenses due to higher price realizations and reduced recoveries across both regions during the 2022 quarter. Costs in the 2022 quarter also increased by $1.11 per ton due to a noncash accrual related to our purchase of the Hamilton mine, which is based upon projections for higher coal sales price realizations in the future. Higher coal sales revenues more than offset increased segment adjusted EBITDA expenses to drive segment adjusted EBITDA from our coal operations higher to $222.6 million, an increase of 95.4% and 68.6% over the 2021 and sequential quarter, respectively. ARLP’s royalty business also performed well during the 2022 quarter. Benefiting from increased royalty sales volumes and sharply higher commodity prices, segment adjusted EBITDA from royalties rose to a record $43.7 million for the 2022 quarter, an increase of 97.4% and 12.4% compared to the 2021 and sequential quarter, respectively. Our financial and operating results for the first half of '22 were also much improved compared to the 2021 period. Coal sales and production volumes increased 16.5% and 16.6%, respectively, while our royalty sales volumes for oil and gas and coal rose 26.9% and 17.3%, respectively, all as compared to the 2021 period. Increased sales volumes and commodity prices drove total revenues higher by 58.2% to $1.08 billion. Increased revenues more than offset higher total operating expenses and income taxes, leading net income higher by 188.1% to $198.1 million for the 2021 period. EBITDA for the 2022 period also increased 86.1% to $396.2 million, compared to $212.9 million in the 2021 period. These exceptional results were achieved despite the continued negative impact on ARLP’s financial and operating results from ongoing transportation disruptions, primarily due to poor performance by the railroads. At the end of the 2022 quarter, approximately 722,000 tons of ARLP’s planned coal shipments were delayed by these transportation issues. We currently expect the bulk of these delayed coal shipments will be delivered over the balance of this year, but we recognize the possibility that some shipments may shift into 2023. I’ll close my comments with a look at ARLP’s updated 2022 full year guidance. During the 2022 quarter, we secured price commitments for the delivery of an additional million tons this year and have modestly increased the midpoint of anticipated sales price realization per ton at our coal operations to reflect these new contracts. We have also slightly increased the midpoint of our expected segment adjusted EBITDA expense per ton due to ongoing impacts from inflationary pressures and supply chain challenges. Considering both of these adjustments, we currently anticipate full year 2022 operating margins from coal will be in line with our previous expectations. Turning to our outlook for ARLP’s royalty businesses, drilling and completion activity of E&P operators on our minerals acreage has resulted in greater than anticipated oil and gas royalty production volumes during the first half of 2022, leading us to increase full year BOE volume expectations by 11.7% at the midpoint. As a result of increased production volumes along with continued strong pricing for oil, natural gas, and natural gas liquids, we expect the performance of our oil and gas royalty segment will exceed our previous expectations. Full year results for our coal royalty segment are expected to be generally in line with ARLP’s previous guidance. And accordingly, we increased guidance for our combined royalty businesses. We have also modified guidance ranges for several consolidated items. Anticipated income tax expense increased $10 million at the midpoint as a result of currently anticipated full year performance of our oil and gas royalties segment. The range for planned capital expenditures in 2022 was also increased $10 million to reflect the addition of a fifth continuous mining unit at our Gibson South mine and another development unit at our Hamilton mine by the end of this year or early next. Finally, estimated net interest expense was reduced to reflect anticipated cash flow expectations. With that, I’ll turn the call to Joe for comments on the markets and his outlook for ARLP.

Thank you, Brian, and good morning, everyone. Global energy market conditions have continued to improve since our last earnings release in early May. Through the first half of this year, commodity prices have risen sharply as worldwide economies struggled to meet increasing power demand in the face of systemic commodity and renewable supply shortages and disruptions related to Russia’s invasion of Ukraine. A confluence of factors has contributed to global shortages of coal, oil, and natural gas. Climate policies by governments and regulatory bodies in the United States and Europe have driven the premature closures of reliable base load power generation and are continuing to influence utilities' decisions on displacing fossil fuel plants with unreliable renewables in an effort to meet arbitrarily imposed deadlines. Many large financial institutions continue to support these efforts by blocking access to capital for fossil fuel producers. Faced with these headwinds, producers have for several years prudently limited investments in fossil fuel production, leading to the current worldwide shortages of coal, oil, and natural gas and a continued reluctance to make meaningful investments to increase supply. This lack of supply response combined with inflationary forces, labor shortages, supply chain issues, transportation delays, and sanctions imposed on Russian fuel sources have all contributed to the current energy crisis facing the world today. Governments and power generators around the world have begun to respond to these challenges by reevaluating their energy portfolios and power generation mix with a focus on energy security and reliability, which has favored natural gas and coal in the near-term. However, it is unclear what actions will be taken that will in fact lead to a supply response significant enough to bring the energy markets more closely in balance and thus a reduction in future energy prices. In the United States, coal stockpiles remain critically low, approaching levels not seen since 2006. With competition from higher-priced export markets and dismal performance by the railroads, domestic utilities are unable to secure the coal volumes necessary to meet their power demand obligations. These utilities, regional grid operators, and public utility commissions have all begun to realize the reality of these market conditions, prompting their recent announcements to delay more than 12 gigawatts of planned coal plant closures, in an effort to ensure adequate grid capacity and reliability for the near future. We believe the decisions made by utilities this year in combination with a higher natural gas price curve for the next couple of years support higher domestic demand for coal and elevated coal prices over the same time period. European utilities are facing similar challenges. In advance of the upcoming ban on Russian coal supply scheduled to occur in the next couple of weeks, API2 pricing remains elevated, recently closing at $370 per ton for fourth quarter deliveries. Attractive net back pricing for thermal and metallurgical exports should provide growth in revenues for several years for U.S. coal producers as well. The countries around the world recognizing the importance of energy security and our customers increasingly seeking to secure long-term reliable coal supply from well-capitalized operators, ARLP has been able to strengthen its contract book. During the 2022 quarter, we entered into new coal sales agreements for the delivery of 24.9 million tons through 2025 at prices above last quarter’s expectations. We continue to believe coal markets will provide attractive opportunities for ARLP through at least 2024 and drive year-over-year margin growth for our coal operations in 2022, as well as 2023 and 2024. In this environment, we remain focused on expanding ARLP’s market share to meet the needs of our domestic and international customers. By phasing in two new units of production in the Illinois basin, we plan to increase our coal sales volume by approximately 1 million tons in 2023. Strong commodity markets should also benefit our oil and gas and coal royalty segments. Record oil and gas price realizations and production volumes resulted in record segment adjusted EBITDA from our oil and gas royalties segment through the first half of this year. With a favorable forward price curve for oil and gas and expectations for volume growth during the back half of 2022, we expect the performance of our oil and gas royalties segment to remain strong. The favorable market conditions supporting the performance of our coal operations are expected to benefit our coal royalties business as well. We continue to believe ARLP is well positioned to deliver solid growth and attractive cash returns to our unitholders. During our last earnings call, we indicated that management was targeting unitholder distribution increases of 10% to 15% per quarter over the balance of this year. And we are pleased that our Board elected to support management’s view by increasing ARLP’s cash distribution to unit holders by 14.3% over the sequential quarter. Reflecting ARLP’s strong year-to-date performance and management’s expectations for the future, our targeted quarterly distribution increase remains intact through the end of this year and is expected to result in approximately 30% of our annual free cash flow being returned to unitholders as we previously communicated. In addition to returning cash to unitholders, ARLP continued to make progress during the 2022 quarter on its energy transition strategy we outlined last quarter. Adding to our earlier investments in EV charging infrastructure through Francis Energy and energy efficiency through Infinitum Electric’s industrial electric motor technology, we announced this morning our $25 million commitment to NGP ETP IV, a private equity fund sponsored by NGP Energy Capital Management, LLC. While ARLP’s commitment to this fund will be deployed over several years, our participation provides us insight to a broad range of investments in companies focused on the growth of renewable energy, the electrification of the U.S. economy and energy efficiency. Through these efforts and others under evaluation, we remain focused on the capital allocation priorities we outlined during the last quarterly earnings call. We firmly believe the fossil fuels ARLP currently provides will remain essential for years to come to meet the immediate energy needs critical to our customers and the communities they serve. By implementing our energy transition strategy investments, we are also well-positioned to meet their energy needs of the future. In conjunction with all these efforts, we remain committed to maintaining a strong balance sheet and achieving record financial results, leading to long-term growth in total returns to our unitholders. That concludes our prepared comments. And I’ll now ask the operator to open the call for questions.

Our first question is from Nathan Martin with The Benchmark Company.

Maybe I’ll start with you mentioned committing an additional 24.9 million tons through ‘25 at prices above your recent expectations, which is a significant amount. Could we get a breakdown of those tons over the next several years ‘23, ‘24, ‘25? Any thoughts on pricing would also be helpful.

Yes. So, as Brian mentioned, we had 1 million in ‘22 and 9.1 million in 2023, ‘24 is 8.5 million and 6.3 million in 2025. As I mentioned, those prices did come in higher than what we anticipated last quarter. As we think about the 2023, if our forecasts are correct for our UI tons, and based on the tons we booked we would expect our average sales price to increase approximately $10 a ton from our guidance for 2022. As Brian mentioned or I mentioned, we believe those margins are also going to expand in 2024. So, that would suggest that those prices could be a little higher in 2024 as well. It’s hard to project exactly what that number would be, because it does have a larger percent of UI. And that’s subject to how the markets will develop over the next year for ‘24, ‘25. So, that’s a guidance I can give you today.

That’s very helpful, Joe. I appreciate that. Maybe another question on ‘23 specifically. You’re now expecting production sales to be up about 1 million tons, as you said, with the fifth unit Gibson South and the extra development unit at Hamilton you said late this year, early next year. Are you guys planning any further expansion at this point, if demand is there, or it’s pretty much how you see sales shaping up this point for next year?

I think it’s dependent on labor. We have seen an improvement in our labor supply this quarter. That’s attributed to there’s been some demand response and some industrial companies in our region that have cut back. And so, that’s created some opportunities for us to hire. We’re hopeful that with our forward look that shows this commitment from our customers over the next several years that that tool will help us and continue to recruit workers to the coal industry. The state of Kentucky, in particular, and Southern Indiana both have a lot of efforts on workforce development to try to go to the young people in high schools and in technical schools to put an explanation or trying to educate these young people about the tremendous opportunities they have in the manufacturing sector of our economy and the growth that’s projected over the next several years. I think that’s bearing fruit. But whether we can increase volume beyond this will largely be dependent on workforce and maybe more importantly on government policy. So, right now, I’m not expecting anything beyond what we’ve announced to get to the bottom line. There are a few things we are looking at that could create some opportunities this year. If we did increase those opportunities this year, it would probably take away from next year. It’s just different ways. We could look at our mine plan that could allow us to bring on a little bit more tonnage. It’s not significant, but there are opportunities with the price. When you look at the market for the fourth quarter of this year, both domestically and export, it’s quite a bit higher than what we would expect next year. So, we are trying to evaluate whether there are opportunities to adjust our mine plans a little bit, to take advantage of that different price curve, but it’s not significant. I mean, it’s meaningful to us, but as far as the guidance we’ve given, it’s all within the ranges of the guidance we’ve provided for 2022.

Got it. Thank you, Joe. I appreciate those thoughts on the labor front as well, because I was going to go there next. So, maybe just curious on the export side. I think, you guys have done as many as maybe 10 million or 11 million tons max at some point historically in a year. Is that still a reasonable maximum number or where do you see that number popping out today?

When we did that, we were producing a little over 40 million tons. Our preference is to sign long-term contracts domestically. If domestic customers agree to three years or more, we would likely sell more tons in that market rather than the export market. However, we are also in discussions with some export customers for long-term contracts, as we seek stability. We have been pleased with the pricing, but we initially expected to sell more export tons this year. Most of our recent sales have been domestic. There might be a small amount in the export market, but the domestic market has matched export pricing. Looking ahead to next year, we have around 8 million tons that remain unidentified, and it will depend on how our efforts go. If the domestic market wants it and commits to 3 million tons at a price comparable to the export price, we would proceed with that. If they choose shorter contracts and there is significant export demand, we could consider selling more than the 5 million tons we are targeting for this year.

Okay. So, that sounds pretty positive, Joe. If I understood you correctly, your domestic customers have been willing to kind of meet you where the export net backs have been or at least close to that area and give duration.

They have in the short-term. As far as the longer term, we’re talking to them about meeting those. The contracts that we got longer term were not at the export levels, but they were still very attractive, given the guidance I gave you that we are going to increase our average sales about $10 a ton.

Just a couple of quick follow-ups. I was wondering if maybe you could first start with the additional million tons that you’re expecting in 2023. Can you kind of give us a sense as far as the timing of that is concerned and when that comes on line and how that spreads through the year?

The majority of that is expected to begin in the first quarter, likely in January or February, depending on our hiring process. Additionally, around 300,000 to 400,000 units should start at the end of the first quarter. Since it's a development unit, its productivity will not match that of our single unit, the CM unit.

It gets back to the timing of when we can get this completed. As Joe mentioned in his opening comments, we’re working to add the development unit at Hamilton and the production unit at Gibson South. Hope to have that in place by the end of the year. But depending on labor, it could end up being completed in the first quarter.

Lastly, can you elaborate more on the recent private equity investment? And also, do you plan on investing in more private equity funds in the future?

Currently, we do not have any additional plans regarding that. I don’t have anything further to add. As for the investment I just discussed, if you have more specific questions, I’m happy to address them without repeating what I've already said.

Thank you. You may disconnect your lines at this time and thank you for your participation.