Hallador Energy Co Q3 FY2020 Earnings Call

Good day. And welcome to Hallador Energy Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Becky Palumbo, Director of Investor Relations. Please go ahead.

Thank you, Andrew. And thank you, everybody, for joining us today. This event is being webcast live and you will be able to access a replay of this call on our website later today. Yesterday afternoon, we filed our Form 10-Q with the SEC for the third quarter 2020 financial and operating results and we also issued a press release with certain financial highlights. Both documents are posted on our website. With me today on this call are Brent Bilsland, our President and CEO; and Larry Martin, our CFO. Larry will begin with a financial overview of the quarter and Brent will follow with our perspective on market conditions and outlook. We will open the call to your questions after Brent’s remarks. Today our remarks may include forward-looking statements that are subject to a variety of risks, uncertainties, and assumptions that could cause actual results to differ materially, for example, our estimates of mining costs, future cost sales, regulations relating to the Clean Air Act, and other environmental initiatives. 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 we projected or expected. We do not undertake to publicly update or revise any forward-looking statements unless required by law to do so. So, with that, I am going to turn the call over to Larry.

Thank you, Becky, and good afternoon, everyone. Let me go over our operating results for the third quarter and year-to-date. For the third quarter, we had net income of $1.9 million, which resulted in a $0.06 per share for the nine months. We had a net loss of $1.5 million or $0.05 a share. Our free cash flow for the quarter was $11.6 million and for the nine months $24.7 million, which we define as net income plus deferred income taxes, depreciation, depletion and amortization (DD&A), asset retirement obligation (ARO) accretion, change in fair value of hedges, and stock compensation, less maintenance capital expenditures and equity investment method effects. Our adjusted EBITDA, which we define as EBITDA plus stock compensation, ARO accretion and change in fair value of hedges, less the effects of our equity method investments in Hourglass Sands, was $17.1 million for the quarter and $44.2 million for the nine months. We paid down debt of $14.2 million for the quarter and $33.2 million year-to-date. Our bank debt as of September 30th was $146.9 million and our net debt was $141.6 million. Our debt-to-EBITDA leverage ratio was 2.46 times, well within our 3.4 times or 3.5 times covenant. I will now turn the call over to Brent Bilsland, our CEO.

Thank you, Larry. During the third quarter, shipments returned to normal, coal inventory was reduced, and aggressive payments were made towards lowering our debt. None of this would have been accomplished without the strong performance of our operations team. COVID has added new challenges for everyone. Yet our operations group has done a remarkable job protecting the health and safety of our people, keeping our cost structure in line, and ensuring our customer shipment needs have been met. Shipments for the quarter were 1.6 million tons, which is a 27% increase over the prior quarter. We expect to ship 1.7 million tons during the fourth quarter of this year. Improved shipments helped us reduce our coal inventory by $4.5 million during the third quarter. However, inventory levels remain elevated at 9.3 million tons year-to-date. We expect to further reduce coal inventory in the fourth quarter of this year. As I stated earlier, COVID has brought many challenges; and out of an abundance of caution, at times up to 25% of our workforce was quarantined due to possible exposure issues. Despite these headwinds, during the third quarter, we were able to maintain production costs at $29.30 a ton, which is within our guidance range. At Hallador, while we have remained intensely focused on creating positive cash flow to aggressively pay down debt, during the third quarter, we paid down $14.2 million and during the first nine months of the year, we have paid down $33.2 million. By the end of 2020, we are targeting that we will have paid down a total of $40 million for the year, bringing our debt down to $140 million, which would represent a 22% reduction in our bank debt year-over-year, all this from a company with a market capitalization of $25 million to $27 million. During the quarter, both our liquidity and our leverage ratios improved to $52.7 million and a 2.46 times debt-to-EBITDA ratio, respectively. This brings our debt to EBITDA leverage ratio a full turn below our covenant of 3.5 times. On April 15th, Hallador received a $10 million loan under the Paycheck Protection Program, and the company expects a portion of this loan to be forgiven in early 2021. Looking forward to energy markets recovering, inventory levels at both mines and utility customers have remained elevated but are improving rapidly. Natural gas prices have improved dramatically, causing coal to dispatch in front of natural gas in most of our markets. For the first nine months of 2020, Henry Hub natural gas prices averaged $1.88; currently, gas prices are around $3.24, and next year’s NYMEX forward strip is at $3.11 as of last night. Next year’s gas prices are higher as the market anticipates less gas production in 2021. One indicator of less future gas production is the dramatic slowdown in oil and gas drilling. Oil and gas rig counts as of October 23rd are at 287, which is down from a peak of 1,085 in 2018-2019, a 74% decline in the number of rigs drilling for oil and gas. Gas-targeted rigs as of October 23rd were at 73, down from a peak of 198 in 2018-2019, a 63% decline. LNG gas prices in Japan have improved dramatically from slightly over $4 in July of this year to $7 today. This is an impressive price recovery in only four months. Eventually, improved LNG prices should lead to better coal exports. Coal export prices have been slow to rise but are improving. API 4 is above $60 now throughout 2021, and API 2 is above $60 in the fourth quarter of '21. In summary, Hallador will continue to focus on generating positive cash flow and reducing our debt. We are encouraged by the recent improvements in all energy markets and are cautiously optimistic about the future. With that, we’ll open up the line to the Q&A session.

The first question comes from Lucas Pipes of B. Riley Securities. Please go ahead.

Hey. Good afternoon, everybody.

Hey, Lucas.

Good afternoon, Lucas.

Brent, I wanted to ask about the pricing side specifically for coal. I’ll get to natural gas in a moment. But on the coal side, what does the current pricing look like if you were to go out and sell spot tons? Looking ahead to 2021 and 2022, some of your peers have noted that there are a couple of utilities that have come forth asking for coal business. What sort of strip could we be looking at here for your average product? I would really appreciate your perspective on this. Thank you.

Well, I think in general the market, like I said, coal inventory levels are relatively high at the utilities. If you go back to March, April timeframe, coal plants just didn’t run very much due to the lockdown. Gas prices were extremely cheap with lower power demand, which likely caused a backup of inventory levels. We’ve now seen that reverse, where coal is dispatching in front of gas in most of our market, and we see those inventory levels come down as we see pretty strong, or at least recently strong, gas prices making two-year highs. So it looks like people are going to burn a lot of coal next year. I think most utility buyers will take a wait and see approach to buy. We don’t expect to see 2021 buying very aggressively here in the Thanksgiving timeframe, which would be normal. We think utilities will wait to see what winter brings from a coal burn perspective, see if gas prices hang in there or go higher, and then eventually pull the trigger. To be fair, I just don’t think a lot is transacting right now. We did have some small spot business pop up in the upper $30 range, but I think those are very few data points to really go by. There were some blend and extend deals that we did this year; we pushed some tons out of 2020 into 2021 and then extended the term of our contracts with customers for multiple years. So that’s kind of what you see happening. I think if gas prices continue to rise by $0.50 or more, people will become more convinced to buy. Right now, they have plenty of inventory and have been chastised for being long in the past, especially with COVID concerns. I just think buyers will take a wait-and-see approach.

That’s helpful. Thank you, Brent, for that perspective. And to hone in a little bit on the gas side, you mentioned the decline in the rig count some of the changes internationally as well, and if you put it all together, what’s your outlook on the gas side? Do you have a sense for how much natural gas supply could be lost on a year-on-year basis in 2021 versus 2020?

Looking more at a high level, we saw the oil and gas industry in the U.S. produce 30 million barrels of oil in '19, and now we’re running more like a 10.8 million barrels a day pace. With Q3 earnings starting to come out, multiple oil CEOs are saying there will likely be a further decline in oil production unless prices get above $40. Right now, we’re down in the mid-$30s. We’re also seeing associated gas; approximately 40% of U.S. gas supply was coming from associated gas. As oil production declines by 20% to 30%, I think we will eventually see some of that associated gas go away. Additionally, in the Marcellus and Utica, we’ve heard from EQT that they are not planning production increases in 2021 because prices aren't high enough to justify costs. Other CEOs are also signaling they’re not incentivized to grow. If gas prices rise beyond $3.50, then buyers will certainly start buying more coal, but right now, inventories are a concern and firms are not transacting on the export side. The markets are currently very unique and while we expect it to be slow at first, back half of 2021 could be more interesting due to decreased production.

Very helpful, Brent. Thank you for that. And since it’s Election Day, could you share your perspective on what a Biden or another term for Trump might mean for the coal sector, specifically in the Illinois Basin?

That’s an easy question. Trump has been very vocal about supporting the transition away from coal. We’ve achieved energy independence and are one of the largest oil producers in the world. If Trump remains in office, there will be a transition away from coal. The question is the pace. Utilities such as Duke Energy have been shutting down coal plants, but they’re signaling that in Indiana, coal has around 15 years left. While there will be a transition, we believe it will take much longer than headlines suggest. Both Trump and Biden will push for less coal, but physics and reliability issues with renewables may cause coal to remain part of the energy mix for longer than anticipated.

Brent, very helpful. I appreciate this answer. Best of luck, and I will pass it over.

Thank you, Lucas.

The next question comes from Mark Kaufman of MLK Investment Management. Please go ahead.

Hey. Good afternoon. Thanks very much for your answers here. I’m kind of a newcomer to the company but familiar with natural gas as a competitor. Great answer. My question is more of a shorter-term question. Natural gas is in backwardation for '21, but not so much for '22. How would the dynamics of the market affect coal prices given this scenario?

That’s a great question. You made a comment about 2022 gas pricing being in backwardation. There are articles suggesting that gas producers are forced to hedge 18 months out for their gas production, which could be causing some of this backwardation. The decline in production from shale wells is significant, which raises the question of how quickly gas producers can ramp up to meet demand. If gas prices rise, it will definitely lead to more coal production. However, many coal producers already have their production capacity ready to go, and we feel more uncertainty as we head towards winter.

Thanks very much.

Thank you.

The next question comes from Eric Fredback of Pacific Value. Please go ahead.

Hey, guys. Thanks for taking my call and congrats on the good quarter. We’re just curious about any of the supply destruction you guys have seen out there on the coal side. I know Archon mentioned that they’re pulling 20 million tons from this year and then trying to reduce that in the next two or three years. So any extra color you have on that and anything else you’re seeing?

Yes, we’ve seen a dramatic pullback in coal production. For example, there were about 14 mines running in Indiana in the first quarter of 2019, with an annualized pace of 34 million tons. Currently, there are roughly six mines running at about a pace of 17 to 18 million tons. We’ve seen some permanent closures and some others idled. Some competitors have laid off their workforce entirely, focusing on reducing inventory. Although these mines can come back, it’s unclear when that might be.

Great. Thanks. So, you said you’re running at about 80% capacity. How high can you get that and still keep production costs under $30 per ton?

We expect our costs to stay below $30 for the balance of this year and into early next year. Our production has been challenged due to COVID, with considerable quarantine issues. It’s been challenging to maintain a fully operational workforce, but we expect to see production improve. If we run harder, those costs will drop a few bucks per ton.

Okay, cool. Thanks. And then one last quick question about your cash flow and debt pay down. What’s your long-term goal for leverage and how far do you want to take that?

Historically, we were a company that was net debt free. We’ve seen how beneficial that can be, and we believe other competitors target a one-time debt-to-EBITDA ratio as an ideal goal. Right now, we aim to pay down debt as aggressively as possible and were on target for a 23% reduction this year.

Okay, great. Well, congrats again on a great quarter and appreciate the help.

Thank you.

Please go ahead.

Hello. Thank you for taking the question. Could you help with a little bit of what we should expect in Q4 from a CapEx standpoint and an inventory reduction standpoint?

Our CapEx for the fourth quarter will be roughly the same as what it has been in the first three quarters, around $5 million or $6 million for CapEx. I think our expected inventory reduction will be similar to the third quarter, about $5 to $5.5 million reduction, although it will still be a little higher than the beginning of the year. Our first two quarters of next year should further reduce this inventory.

Excellent. And one last question, what is the price of natural gas that would allow Indiana coal to dispatch in front of it?

That varies by utility, but I'd say around $2.30 at Henry Hub is a good general range.

Great. Thank you very much for taking the question.

Thank you.

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 to listen to our call today and specifically all those that asked questions. We appreciate your interest and I look forward to talking to you next quarter. Thank you.

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