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Good morning and welcome to the Alliance Resource Partners Second Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.
I would now like to turn the conference over to Brian Cantrell, Senior Vice President and Chief Financial Officer. Please go ahead.
Thank you, Gary. And welcome, everyone. Earlier this morning, Alliance Resource Partners released its 2018 second quarter earnings and we will now discuss these results as well as our outlook for the balance of the year. Following our prepared remarks, we will open the call 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 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, actual results may vary materially from those we projected or expected.
In providing these remarks, the partnership has any 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 will also be discussing certain non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP measures and their most directly comparable GAAP measure 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 turn the call over to Joe Craft our President and Chief Executive Officer for his take on our second quarter performance, our perspectives on the coal markets and ARLP’s outlook for the remainder of 2018. Joe?
Thank you, Brian. Good morning, everyone. I hope you would agree with me that Alliance’s financial and operating performance during the 2018 quarter was impressive. Recovering from weather-related transportation disruptions earlier this year, barge, rail and port operations for the most part have returned to normal.
As a result, ARLP was able to deliver substantially all of the 1.4 million tons of coal shipments delayed during the sequential quarter. This led to strong coal sales volumes which enabled ARLP to post increases to all of our major operating and financial metrics for the 2018 quarter compared to the 2017 quarter.
Our marketing team continued to strengthen ARLP’s contract book during the 2018 quarter, securing new commitments in both the domestic and international coal markets to deliver approximately 13.5 million tons through 2021, including an additional 4.6 million tons of export shipments over the next 12 months to 18 months.
We are now essentially sold out for our planned production in 2018 and have increased ARLP’s anticipated export sales for this year to approximately 11.1 million tons or 27% of estimated shipments this year.
Operationally, our mines performed well, delivering operating costs consistent with the sequential quarter as we expected. We also increased production by 2.6% to serve the growing export demand in the 2018 quarter as well as the 2018 period.
Looking ahead, we anticipate market conditions should remain favorable for both domestic and international coal demand.
In the US thermal markets, strong demand has reduced utility coal inventories by approximately 15% year-over-year. As a result, customer buying activity has increased with utilities looking to replenish stock piles in 2018 and secure open positions for 2019 and beyond. The export market’s strong fundamentals continue to create opportunities for ARLP to participate.
The seaborne thermal markets remain attractive and we have now booked 10.4 million and 3.1 million tons for delivery to these markets this year and next. The forward price curve for seaborne thermal coal remains supportive to ARLP’s continued participation in these markets.
Pricing in the metallurgical export markets has also been constructive and year-to-date we have now booked commitments to deliver approximately 725,000 tons in 2018, echoing the volume we delivered to these markets all of last year.
For 2018, with the anticipated production increase at Gibson North, ARLP’s total production this year is on track to be almost 3% higher than 2017. We expect to grow our production another 5% to 6% or approximately 2 million tons in 2019 compared to 2018. Essentially, all of this additional production will come from the Illinois Basin, targeted primarily for the export market.
ARLP’s strong performance for the first six months of 2018 and our favorable outlook for the balance of the year, led us to again increase full year guidance for revenues, net income and EBITDA.
We continue to believe our anticipated 2018 performance will result in strong distributable cash flow and distribution coverage, supporting management’s expectation of increasing unitholder distributions by approximately 1% per quarter for the rest of this year.
ARLP also achieved a significant milestone during the 2018 quarter, completing a process that began in July of 2017 with the IDR Exchange Transaction. We closed the transactions to simplify the Alliance Partnership structure at the end of May.
As a result of these transactions, ARLP is now the only publicly traded Alliance entity, allowing ARLP to increase investor transparency, attractive broader investor base to the single larger entity with increased public float and greater liquidity and eliminate the duplicate costs required to maintain two public companies. Progress on our priority to invest in ARLP’s core coal business also continued during the 2018 quarter.
The first of two continuous mining units began production, operations at our Gibson North mine and the second unit is scheduled to come online by the fourth quarter of this year.
Additionally, production from these two mining units and the potential to ultimately increase capacity of Gibson North to a total of four continuous mining units will allow ARLP to meet increasing demand from the export thermal coal markets.
As I mentioned on our last call, we continue to evaluate an opportunity to maintain ARLP’s market share for low-sulfur, high BTU coal due to potential development of a new coal mine in East Kentucky as reserve deplete at our MC Mining operation in 2020.
Results to-date from ARLP’s investments in oil and gas minerals and gas compression services have been better than expected, leading us to increase the expected contribution to ARLP’s 2018 results to a range of $35 million to $40 million.
I continue to be optimistic about ARLP’s future and our ability to generate cash flow growth over the long-term. This confidence has encouraged us to remain focused on returning cash to ARLP’s unitholders. The increased distribution just announced by our Board is one way ARLP is committed to returning cash to our unitholders.
In addition, ARLP began executing on the $100 million unit buyback program authorized by our Board in May.
During the 2018 quarter, we acquired approximately 384,000 units for a total cost of $7.6 million. These repurchases, along with units contributed to ARLP by affiliate, in conjunction with the simplification transactions, reduced ARLP’s unit count by approximately 851,000 units. At the end of the 2018 quarter, ARLP had approximately 131.4 million units outstanding.
We continue to believe that ARLP’s strategy of focusing on sustainable long-term cash flow growth and returning cash to unitholders, while maintaining strong distribution coverage and distribution coverage and a conservative balance sheet, will serve us well by creating value for our unitholders in the future.
I’ll now turn the call back to Brian for a more detailed review of our results. Brian?
Thank you, Joe. As mentioned earlier, ARLP reported strong financial results for the 2018 quarter and period. Looking first at our results for the quarter compared with the 2017 quarter, coal sales volumes increased 23.9%, as we made up weather-related shipment delays from earlier this year and increased our export volumes.
Led by higher production at our Gibson South and River View mines and the resumption of our operations at Gibson North, coal production increased 2.6% during the 2018 quarter.
Increased sales volumes and slightly higher coal prices drove coal sales revenues for the 2018 quarter, up by 24.5% to $475.9 million. And along with a 38.9% jump in other sales and operating revenues, primarily from our Matrix and Mt. Vernon subsidiaries, led total revenues, excluding transportation revenues higher by $97.3 million, compared to the 2017 quarter. Increased coal sale volumes also contributed to higher operating expenses of $311.2 million in the 2018 quarter.
Segment adjusted EBITDA expense per ton was flat sequentially, but increased 5.6% compared to the 2017 quarter, primarily due to difficult mining conditions encountered during the 2018 quarter at several Illinois Basin operations and our Tunnel Ridge mine in Appalachia.
For the 2018 quarter, net income attributable to ARLP and EBITDA rose 36.3% and 26.7% respectively, both compared to the 2017 quarter. In addition to the factors just reviewed, results for the 2018 quarter also reflect a contribution of $8.7 million to net income and EBITDA from our investments in oil and gas minerals and gas compression services, an increase of $5.8 million compared to the 2017 quarter.
Comparative results between the 2018 and 2017 quarters were also impacted by the $8.1 million debt extinguishment loss related to ARLP’s early repayment of its Series B Senior Notes in May 2017, which was done in conjunction with our bond offering in April of last year.
As a reminder, the IDR Exchange and Simplification Transactions impacted total units outstanding and the allocation of net income to our general partners, creating the lack of comparability of earnings per unit between periods.
We have again included at the end of this morning’s earnings release, a comparison of ARLP’s actual EPU and pro forma EPU as if the Exchange and Simplification Transactions had occurred on January 1, 2017. On this pro forma basis, EPU for the 2018 quarter increased by 34% to $0.63 compared to $0.47 for the 2017 quarter, and by 43.2% to $1.79 per unit for the 2018 period compared to a $1.25 for the 2017 period. We will also again provide investors with a detailed pro forma presentation at ARLP’s EPU in our upcoming Form 10-Q filing with the SEC.
The factors we have discussed this morning also contributed to ARLP’s strong results for the first half of 2018. Coal sales and production volumes, revenues, net income and segment adjusted EBITDA, all increased compared to the 2017 period.
On a per ton basis, slightly lower coal sales price realization and higher segment adjusted EBITDA expense drove year-over-year segment adjusted EBITDA lower by 8.8%. As noted in our current guidance, however, we currently anticipate ARLP’s performance over the next six months moves up on slightly higher segment adjusted EBITDA per ton for the 2018 full year compared to 2017.
Net income attributable to ARLP increased $74 million to $242.1 million for the six months ended June 30, 2018, compared to $168.1 million for the 2017 period. The increase was due to higher revenues and investment income, a net gain on settlement of a litigation from the sequential quarter and the 2017 debt extinguishment loss I discussed a few minutes ago, partially offset by higher operating expenses and depreciation, depletion and amortization.
Turning now to the balance sheet, we ended the 2018 quarter with ample liquidity of $672.4 million and leverage remains conservative at 0.86 times total debt-to-trailing 12 months adjusted EBITDA. Our strong conservative balance sheet provides ARLP with the financial flexibility and capacity to execute our plans and take advantage of future opportunities.
This concludes our prepared comments. And now with the operator’s assistance, we’ll open the call to your questions. Gary?
We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from John Bridges with JPMorgan. Please go ahead.
Hi. Good morning, Joe, Brian. Congratulations on the results again. Well done.
Thank you, John.
I was just wondering, the Gibson -- the expansion at Gibson North, the 2 million tons of additional production you’re talking about next year, would that largely be coming from Gibson North, 1 million tons to [CM] unit or is it more distributed around the other across the space?
Yes. It mostly will come from Gibson North. There are some incremental production at couple of our other Illinois Basin mines that we expect in 2019 compared to 2018, some based off of some volumes in 2018 that didn’t meet expectations that we -- the reality is, it’s going to be more favorable in ‘19 compared to ‘18.
So it should be relatively sulfur discount free on that stuff?
There is still some slight discount at Gibson, but it’s not as much as it is at our other 3% coal mines.
Okay. Good. And as you reported the oil and gas section is stronger, is there a sort of sensitivity of those, that income to oil and gas price that we could use going forward that would help us predict earnings?
It’s -- I would say going forward the price is not as much as an issue as volume. So, we’re seeing our first investment and our second investment becoming more mature. So, as our guys bought those properties ahead of the drill bit, the drill bit -- the property -- the drill bits are coming closer to where those properties are. So it’s going to be more volume driven than it is price driven. So we do have pretty good visibility and we do expect to see improved earnings going into ‘19 and ‘20 as a result of just timing of when those reserves were bought, and when we see the drilling coming towards the reserves that were purchased.
And then we would appreciate your insight as to what’s going on into Illinois Basin coal pricing. So I wondered if you could just comment on that finally.
We have seen improvements on the domestic side. And I would say that just last quarter prices were up probably 10% at least and it is as I suggested last quarter I believe that we are in balance as far supply and demand, there’s expectations that some utilities will be out looking per tons into 2018. I don’t know that there’s much supply out there for 2018. So we would expect that those utilities will be growing from inventory and then they will need to buy a little bit more in ‘19 than what they did in ‘18 to replenish the stocks. So we’re -- we feel good about where the price curve looks relative to 2017, 2018 on Illinois Basin pricing. So hopefully that answers your question.
The next question comes from Lucas Pipes with B. Riley FBR. Please go ahead.
I wanted to follow-up on the pricing side and you disclosed -- first off good job on the contracting. But in terms of the committed price tons for 2019 I believe it’s 24.7 million tons. And I wondered if you could comment directionally how those prices -- how the prices on those committed tons would compare to 2018? Thank you.
I can’t give you exactly how they commit. I don’t have that breakdown specifically for the committed tons. But as we look at our revenue projections for 2019 compared to ‘18, we believe they’re going to be favorable with the one wild card being metallurgical coal sales and both price and volume. So it’s hard to predict exactly what that price would be. So for example, if we had no met coal sales next year, then our average sales price might be lower by a couple of bucks, consolidated, as an example. But if we were able to maintain pricing that we had in ‘18, volume and price for met coal, we should see slightly higher average sales prices by a buck or so.
Got it. And that’s -- so a buck or so higher on averaging holding met coal flat in 2019?
Yes. If we were able to keep the volume and the pricing, then that would show some improvement consolidated, if we show something fine. It’s really too early to tell. But my best guess right now is, our revenue on a per ton basis should increase be equal to where we are this year, assuming we get any type of volume out of the metallurgical business next year.
Got it. Okay, maybe to switchover to the cost side, I believe this year you’re guiding to 1% increase but with the favorable impact from the mix. If we kind of were to look at it on a same mine basis so to say, do you have a sense of where cost inflation is running?
So we have seen some uptick on anything that’s steel related that flows through and we have also given some -- there have been some labor cost increases, where we’ve given some increases throughout the operations this year. So that said, from a cost perspective, it’s probably in the 2% range for those items that have inflationary aspects to them. So there are certain items that are in our costs, that’s not 100%, toward logistics year in, year out. But of those variable cost components, it’s probably in that 2% range would be my guess.
Yes, Lucas, part of the cost differences we have seen so far this year compared to what we were initially thinking where we thought we might see a slight improvement in 2018 versus 2017. At that time, we were not expecting or planning in our guidance for any metallurgical sales. And obviously there is a higher cost associated with producing a met product than a thermal product. So there is a variety of factors that Joe just referred and sales mix is a part of that equation.
And that 2% really was over the total, so it’s probably going to be 3% specifically on those items with any type of inflation component to it, so I want to correct that.
Got it, okay. And then maybe one last bigger picture high level question. Obviously the export market has been a tremendous benefit to you and I would argue the entire US coal industry. How sustainable do you think that is? Obviously it tends to be somewhat of a cyclical market. Do you see that US participating longer term and throughout the cycle or what you said the US is still maybe what is commonly described as a swing supplier? Thank you.
We believe that it has more sustainability going forward. We’re continuing to see new coal-fired generation being built around the world, even most of which maybe in Asian markets, but there is enough in Africa and -- Northern Africa and Europe, areas India basically, where there will be increased demand and also see Turkey opening their markets to the high sulfur coal. So we do believe that the demand is going to be there. We’re really not seeing a supplier response anywhere around the globe. So, we have no reason to believe that we can’t maintain our market share if you will or Illinois Basin product. And as John alluded to earlier, our Gibson product is really a lower sulphur product compared to other Illinois Basin mines. So we can compete with a very low cost surrounding at Gibson and it’s low sulfur content that gives us confidence that we can in fact grow our export market for the foreseeable future.
Got it. Do you believe there is a limit as to how much the US can export either from a infrastructure perspective or in terms of the market being saturated with US coal at a given point?
There is a limit. So we’re looking at the Gulf I think has a little bit more capacity from a transportation perspective. The East Coast, it really depends again on metallurgical markets. But we’re not talking heat volumes here. I think we’ve talk about 2 million tons out of 50 million for us and even if the two other players that are in the market have us -- having equal amount, we’re only talking about 6 million tons or 10% say of what we did this year. And that’s a very large global market that’s growing. There is a plant in Latin America right now in the market running about 2 million tons as an example. So, for the -- if you keep it within the region in like I say 5% to 10% increased range, it’s definitely doable. And if you want to try to double with, yes, there would be limits.
The next question comes from Mark Levin with Seaport Global. Please go ahead.
Great. Thank you very much. And congratulations on another solid quarter. A couple of quick questions. One relates to some of Joe’s comments around 2019. Last quarter, I think you mentioned when you’re kind of looking at the world, Joe, you felt like margins in ‘19 would be comparable to 2018, based on your initial look. I realized the met situation -- the met coal situation can the change the view. But do you feel any more or less confident about that statement about ‘19 margins being comparable to ‘18, three months later?
I think the conclusion is the same, but I do feel more confident in that statement, given the activity, the receptivity, the communication we’re having with customers, how much tonnage we’ve put to bed, how much we’re continuing to talk and have dialogue. I think that as we look at going forward, even though we still have quite a few tons of sale, we do feel confident in our ability to sell those tons. And so, I think again the conclusion is probably the same as far as what that margin is. But our confidence level knowing that when we produce it, we can sell it at those margins is higher today than it was a quarter ago.
That’s great. That’s great to hear. Second question relates more to uses of cash. I know you guys initiated a $100 million buyback. You bought back $7 million this quarter. I think Brian alluded to total debt-to-EBITDA being roughly 0.9 times at the end of last quarter. When you look at the units as they are today and I guess on our numbers we have sort of a mid teens type free cash flow yield, might even be a little bit higher than that. But just a tremendous free cash flow yield relative to the other opportunities you see out there, whether it’s through developing another coal mine or going out and buying other coal mines or even featured oil and gas investments. Are you seeing opportunities out there to buy that or build that provide you with the same, if not better, risk adjusted returns than let’s say buying back your stock more aggressively?
I think last quarter we were looking at several things that we felt we could bring into a transaction this year. Those things have run away from us for whatever reason. So there are still other things we’re pursuing. I think we’ll continue to measure both. I don’t think we have to choose between one or the other, because of our balance sheet the way it is. So we’re continuing to look for investing in assets that would be our first priority. But we’re also believing that buying the stock is a good investment as well. So, it’s hard to comment, because things change daily in this business. So we’re actively just looking to be able to grow our company and grow our cash flow to match for the long-term. So that’s what we did.
Yes. And Mark, our capital allocation priorities remain the same. We -- as Joe just alluded to, we’re first focused on investing in our core coal business, and as well as potentially outside of coal to grow long-term cash flows. And then the second priority is to return cash to unitholders either through distribution growth, unit buybacks or a combination of the two. And we’re really not in an either-or situation. We can adjust for the opportunities that present themselves and continue to move forward as we try to consistently articulate that for some time now.
I know. And you guys do. It was just -- it was more around the fact that I think your leverage is so low and at least from my perspective the stock is cheap and does that give you an opportunity to maybe accelerate buying back with such a high return opportunity that may not be there down the road, if the stock is very much higher?
Looking at our 2018, we just announced it at the end of May. So we didn’t have them -- we only had like two weeks to [execute].
That makes sense, yes.
So you can’t look at last quarter as being a full quarter. So it goes back to that end as well.
No, that totally makes sense. Okay. And then the third question was more around export margins. Sitting with high API2 prices where they are, maybe could you comment a little bit on what from a margin perspective in the current environment, what you guys might realize for a low sulfur product versus what you might realize for a high sulfur product? And just to give us maybe some comparability relative to what that looks like versus the domestic market?
I would say the sulfur discount sort to speak is probably two-thirds lower, when you try to factor in on the revenue side of the equation and on the cost side our Gibson product is our lowest cost mine pretty much. So I don’t want to get into specifics on margins. But that business is very profitable for us.
The next question comes from Lin Shen with HITE. Please go ahead.
Hi, good morning. Thanks for taking the call. You mentioned that the oil and gas, the revenue is growing and also you are confident that they will grow in next year based on the current volume expectation. Do you think that they can grow at the similar growth rate like this year, do you?
Obviously, it’s dependant on the two factors we discussed earlier, pace of drilling of the operators begin executing the development of our acreage and also pricing. But from what we can see, anticipation of a similar level of growth year-over-year is certainly possible.
I just wanted to clarify, I believe Joe mentioned before that the -- do you have a lot of price activity or volume is more important factor?
It’s really going to be more volume driven rather than price driven.
Okay, great. Thank you very much.
[Operator instructions]. The next question is a follow-up from Lucas Pipes with B. Riley FBR. Please go ahead.
Yes, thank you for taking my follow-up. Joe, I wanted to -- and Brian as well, I wanted to follow-up on share repurchase program, I believe it’s been out now for about two months. What’s your initial kind of take on it, would you say success, the market maybe didn’t fully appreciate it. What are your comments and if you feel so inclined -- maybe including your answer, an inclination as to whether it may change your capital allocation priority? Thank you.
I think the execution thus far; it’s a little bit too early to tell. Again, we announced it a week or two weeks in advance of our trading blackout period. So there was a relatively short period of time where we were in the market. Our blackout period will end here very shortly and we expect to be back in the market. We’re evaluating -- we have been trading under a 10B-18 program or evaluating whether we’ll incorporate a 10b5-1 program as well to expand the period during which we can trade. But we’re frankly going to take a little bit of a wait and see approach to watch how the market responds to the activity that we maybe engaged in over the next four to six weeks or so.
So I think that’s what you could expect to see from us at this stage.
Regarding the capital allocation priorities, no, I don’t see those changing and I think we elaborated on that. I think we were responding to I think Mark’s question a little while ago.
This concludes our question-and-answer session. I would like to turn the conference back over to Brian Cantrell for any closing remarks.
Thank you, Gary. We appreciate everyone’s time this morning, as well as your continued support and interest in Alliance. Our next quarterly earnings release and call are scheduled for late October and we look forward to discussing our third quarter 2018 results with you at that time. This concludes our call and thanks to everyone for your participation.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.