|Shares Out. (in M):||18||P/E||0||0|
|Market Cap (in $M):||46||P/FCF||0||0|
|Net Debt (in $M):||380||EBIT||0||0|
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We believe Contura Energy (“CTRA”) shares represent a highly convex value investment opportunity in the United States’ largest metallurgical coal producer. CTRA is trading at 1.9x 2020 consensus EBITDA with a market cap of $46mm. We believe the share price does not reflect the underlying earnings potential of the company. On a normalized basis, we believe CTRA can generate more than $500mm in EBITDA and $300mm in free cash flow, which suggests a market capitalization north of $1,000mm versus $46mm today. This would result in a more than compelling equity return of more than 20x. CTRA started 2019 with a market cap north of $1,000mm and we believe the company is better today than it was then. We believe insiders recognize this significant return potential, indicated by recent buying activity from CTRA’s CEO, an experienced and well-regarded coal operator with a history of creating value for stakeholders.
It is important to note at the outset that CTRA is under significant stress at current metallurgical coal prices (~$130/ton) and announced on Friday (April 3rd) that it was idling the majority of its operations for 30 days, presumably a measure to preserve liquidity. If metallurgical coal prices do not improve over the next 12-24 months, CTRA’s operations may burn cash to a degree that exhausts available liquidity. This would likely drive CTRA’s equity value to zero.
Benchmark metallurgical coal prices have averaged ~$180 over the last decade, however, and we believe that the global cost curve supports prices significantly above current levels. Fundamentally, this trade works best in a scenario where the world is back to normal within 12 months (i.e. automotive sales recover, lockdowns end, industrial production picks up, etc.).
CTRA is North America’s largest metallurgical coal producer, operating mines in West Virginia and Virginia that produce ~12.3mm tons annually (midpoint of 2020 guidance). CTRA also produces thermal coal, primarily from its Cumberland mine in Pennsylvania (annual output of ~6.4mm tons).
CTRA was formed as a carve-out of Alpha Natural Resources (“ANR”) during ANR’s bankruptcy in 2016, and subsequently re-merged with ANR RemainCo in November 2018 (after each company had divested non-core assets), driven by a desire to regain operational scale, take advantage of high metallurgical coal prices, and list on the NYSE to obtain equity currency for additional consolidation of the US metallurgical coal industry.
In 2019, CTRA encountered operational difficulties reintegrating ANR RemainCo, leading to a series of negative guidance revisions and cost overruns. Simultaneously, seaborne metallurgical coal prices declined steadily throughout the year from $228/ton on 12/28/18 to a low of $133 on 11/27/19, due to a variety of macroeconomic concerns and a cap on metallurgical coal imports by China, the world’s largest coal importer. The combination of these factors drove CTRA’s stock price from $65.74 on 12/31/18 to $9.05 on 12/31/19, and the stock has continued decline in 2020, closing at $2.54 on 4/7/20.
We believe that CTRA’s struggles in 2019 have been resolved, that the company is executing on a variety of strategies that will create value for shareholders, and that the industry backdrop is favorable.
Management has been replaced by experienced operators with a history of creating value.
On July 29, 2019, CTRA announced David Stetson as its new CEO, after a three month period where CTRA was without a full-time CEO (Kevin Crutchfield, the prior CEO, left the company in May 2019). Mr. Stetson is a well-regarded coal operator who, after leadership roles at other coal companies, was brought into run ANR after its restructuring in 2016 and had previously sat on CTRA’s board.
Mr. Stetson promptly set out to streamline the company’s operating and organizational structure, including, among other items:
· Shrinking CTRA’s Board from nine directors to six, and replacing directors who had overseen significant value destruction with shareholder advocates (i.e. Scott Vogel)
· Rightsizing CTRA’s executive team by eliminating four named executive officer positions, realizing millions of corporate cost savings
· Replacing CTRA’s Chief Operating Officer with ANR’s former COO, Jason Whitehead, who is regarded as a best-in-class operator with excellent cost management and mine execution skills
Since taking the reins, Mr. Stetson has overseen:
· Reduction in metallurgical coal operating costs per ton from $83-$87 (2019 guidance at 2Q19 call – last call under old management) to $76-$81 (2020 guidance at 4Q19 call), or $80mm of cost improvement at the midpoint of 2020 production guidance, driven almost entirely by simply operating the mines more efficiently (credit to Jason Whitehead)
o We believe 2020 guidance is conservative, as management commentary on the 4Q19 earnings call in late March 2020 indicated CTRA was running at or below the bottom end of cost guidance for most of 1Q10
· Reduction in SG&A from $60-$65mm (guidance as of 2Q19 call) to $50-$55mm (guidance as of 4Q19 call)
CTRA has a pipeline of projects with lower cost profiles
In 2020, CTRA is bringing on three new mines, all with cost profiles below the average of CTRA’s existing footprint. The production is partially replacement for existing mines reaching end of life, partly incremental, and will have a significant impact in further operating cost reductions.
We believe CTRA’s true cash generation power is obscured by legacy obligations which are rolling off
As part of the reintegration with ANR RemainCo, CTRA assumed various legacy cash liabilities, totaling more than $50mm in 2020, which CTRA estimates will decline to almost zero by 2023. This dynamic alone unlocks more annual cash flow than the current market capitalization of the company.
We believe CTRA’s public equity is valuable currency for consolidation
The metallurgical coal landscape in the United States contains multiple sub-scale and/or private coal producers where equity holders have limited ability to exit their investment and the operations suffer from poor management. We believe these companies represent motivated sellers, and we believe that CTRA equity, even at its current depressed prices, is a valuable currency for CTRA management to complete accretive transactions.
One example of the scale of this potential value creation is a case study of Blackhawk Mining, a metallurgical coal producer in West Virginia / Virginia with mines proximate to CTRA and investors which own the equity through a restructuring with no clear path to exit. Blackhawk has recently announced suspension of all mining activities and has a substantially higher cost structure than CTRA.
We believe a merger between CTRA and Blackhawk, conducted on a net asset value neutral basis to avoid dilution of CTRA equity value, would be accretive to CTRA shareholders on a number of levels, including competitive rationalization, optimization of mine footprint, overhead cost reductions, and other items. In 2018, Blackhawk offered to acquire CTRA, and at that time industry sources (see article here) estimated $200-$300mm of synergies from the combination. For perspective, CTRA’s 2020 consensus EBITDA is $225mm.
Global metallurgical coal supply is shrinking, which we believe provides fundamental price support
In contrast to the prior downturn in metallurgical coal pricing circa 2015, which was preceded by a significant increase in supply from global majors like BHP, the last several years have been remarkable for the lack of supply growth, and by the rapid reduction of supply in response to the current pricing downturn. No new large mines have come online in multiple years despite global steel demand growth, driven by spending discipline by the producers and capital markets’ unwillingness to provide financing. And as prices have declined since 2019, existing mines have quickly exited the market. Out of a ~300mm ton global seaborne metallurgical coal market, the US alone has seen ~8mm tons come offline, including many subscale “mom and pop” operations, which we believe represents tons that will not return in a recovery, while better capitalized operators may decide to bring tons back online in a higher price environment. Even the lowest cost producers in the world (Australia) are halting growth projects, with the ~6mm ton Ironbark project (previously scheduled to come online early this year) halted indefinitely. Vale’s perpetually troubled Mozambique mine shut production for 3 months in late November 2019, and has yet to announce resumption of mining. Most major producers expect 2020 production to decline YoY, and the few that don’t expect slight YoY increases driven by productivity improvements rather than large capital spend.
Putting all the pieces together, we believe global metallurgical coal supply will decline by low single digit percentages YoY, before factoring in the ~4% annual depletion rate of existing mines. 2019 was also a remarkably calm weather year, with no meaningful weather or logistics infrastructure disruptions which, in an average year, take 3-4% of global supply offline. Compared to a long-term average steel demand growth rate in the 2-3% range, and with marginal cost of production in the ~$160-$175 context, we believe there is substantial macro support for prices that, while they may temporarily deviate above and below that range, enable CTRA to generate strong financial returns.
Insiders are buying.
2019 insider transactions look distinctly negative, driven by an unpleasant combination of disinterested executives cashing out and directors who had ridden through the restructuring liquidating their options received during that process. Insider behavior has inflected, however, with Mr. Stetson acquiring 35,000 shares since late November 2019, and 25,000 shares in March 2020 alone. We believe this represents the “smartest people in the room” recognizing the tremendous earnings capability of CTRA - something that is not recognized in the current share price.
We believe the company has liquidity to weather a short downturn.
At 12/31/19, CTRA had more than $350mm of liquidity, and expects to receive another ~$125mm in tax refunds over the next three years. It is also likely that the company could find additional liquidity through equipment financing facilities, something that other metallurgical coal producers (e.g., Arch) have recently implemented. We believe this provides CTRA with the ability to survive a short downturn in pricing and demand, although it is unlikely to survive a prolonged period of weakness.
We believe CTRA offers option-like returns from common equity investment if the global economy recovers in the near term. The company has transformed itself from a high-cost producer with questionable management to a streamlined industry leader with skilled operators at the helm. On an undemanding 3x multiple of normalized EBITDA, net of the $550mm term loan, a ~$1,000mm market cap merely takes the company back to where it was last year, and would return equity holders more than 20x their money.
Normalization to LT avg met coal prices
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