Arch Resources, Inc. (NYSE:ARCH) Q1 2024 Earnings Call Transcript

Arch Resources, Inc. (NYSE:ARCH) Q1 2024 Earnings Call Transcript April 25, 2024

Arch Resources, Inc. misses on earnings expectations. Reported EPS is $2.98 EPS, expectations were $3.49. Arch Resources, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen, and welcome to the Arch Resources Incorporated First Quarter 2024 Earnings Call Conference Call. [Operator Instructions] This call is being recorded on Thursday, April 25, 2024. I would like to turn the conference over to Deck Slone, Senior Vice President of Strategy. Please go ahead.

Deck Slone: Good morning from St. Louis, and thanks for joining us today. Before we begin, let me remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, may be considered forward-looking statements according to the Private Securities Litigation Reform Act. Forward-looking statements, by their nature, address matters that are to different degrees, uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we filed with the SEC, may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements, whether as a result of new information, future events, or otherwise, except as may be required by law.

I’d also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we’ve posted in the Investors section of our website at archrsc.com. Also participating on this morning’s call will be Paul Lang, our CEO; John Drexler, our COO; and Matt Giljum, our CFO. After our formal remarks, we’ll be happy to take questions. With that, I’ll now turn the call over to Paul. Paul?

Paul Lang: Thanks, Deck, and good morning, everyone. We appreciate your interest in Arch and are glad you could join us on the call this morning. I’m pleased to report that during the first quarter, Arch continued to drive forward with our consistent and proven plan for long-term value creation and growth despite some headwinds. During the quarter just ended, the team achieved an adjusted EBITDA of $103 million and generated $83 million in discretionary cash flow, delivered a $56 per ton cash margin in our core metallurgical segment, underscoring the durability of our cash-generating capabilities across a wide range of market environments. Reduced our outstanding share count by 3%, which included 315,000 shares associated with the unwinding of the capped call instrument, and have repurchased of an additional 95,000 shares.

Prior to a quarterly cash dividend of nearly $21 million, or $1.11 per share payment in general, perhaps the most importantly extended our industry leadership and sustainability as the state of West Virginia named Leer and Leer South co-recipients of the state’s top safety and honored Leer South with the state’s top environmental. As we’ve noted many times in the past, a capital return program is the centerpiece of value propositions. We’ve now deployed more than $1.3 billion through this program since its relaunch in February 2022, a figure equivalent to 46% of our current market capitalization in a period of just over two years. Breaking that down further, we’ve paid $727 million for nearly $39 per share in dividends over that timeframe, while reducing our share count by 3.5 million shares, or roughly 16% versus the peak level in May 2022.

As indicated, this last component, the systematic reduction in our share count, has taken center stage and is receiving our intense focus. We’ve already made significant progress on this front over the last two years, reducing the share count from 21.9 million shares in May 2022 to 18.4 million shares in May. Along with this, we believe we position the company to drive even greater progress in the quarters ahead through our efforts to streamline the capital structure over the last two years, including the retirement of our convertible debt, the elimination of our loans, and the recent liquidation of our capped calls and our decision to build a substantial cash balance to facilitate the opportunistic buying of our shares during market pullbacks.

In short, we believe the stage is set for ongoing investment in Arch’s compelling long-term prospects for a strong and sustainable share repurchase program. Turning to the coal market dynamics. After declining steadily throughout the first quarter, seaborne coking coal prices appear to have found a base in the last two weeks and are beginning to show signs of a rebound. At present, Platts is assessing High-Vol A coking at $220 per metric ton FOB the U.S. East Coast, versus an average of $285 per metric ton on the same basis just last December. It’s worth noting that despite the relative market softness year to date, certain demand fundamentals appear generally supportive. For instance, global hot metal output for the world excluding China was up 2% during the first three months of the year, while China’s imports of high-quality seaborne coking coal continue to trend higher.

Counterbalancing those positive indicators, the supply side has recovered modestly year to date, with Australian and U.S. coking coal exports rebounding somewhat, albeit to levels significantly below their respective peaks. It’s important to point out, as a world-class competitor with a first quartile cost program, Arch is exceptionally well-positioned to manage through extended periods of market weakness while still driving value for shareholders. In fact, periods of market weakness can be healthy in our view, by differentiating the stronger operators and reinforcing the fact that this is a commodity business, the cycles that ebb and flows, and being a low-cost producer does matter. But we also continue to believe in our longstanding thesis that underinvestment and ESG-related constraints will continue to support a constructive long-term supply-demand balance in global coking coal markets.

In fact, those dynamics could spur a quick recovery in such markets if global economic conditions start to strengthen, our major economies begin to increase their steel-intensive stimulus spending. It’s also worth noting that recent price declines may already be taken in toll on high-cost U.S. operations. In recent weeks, several small coking coal mines have closed sections or ceased production entirely, according to market intelligence. Turning now to the thermal markets, U.S. fundamentals remain challenged at present, with natural gas trading below $2 per million Btu at Henry Hub and utility stockpiles at historically high levels after the mild winter. These natural factors in turn drove an estimated 10% decline in domestic thermal coal production on a quarter-over-quarter basis.

On a more positive note, the seaborne thermal market has rebounded somewhat, with the prompt Newcastle price standing at $130 per metric ton and API-2 at $119 per metric ton. Due in part to this improvement in the price environment, U.S. thermal coal exports were up roughly 26% for the first two months of 2024 when compared to 2023. Looking ahead, we are sharply focused on driving continuous improvement across our operating platform in support of ongoing and value-generating capital returns for our shareholders. At the same time, we are continuing to capitalize on the strategic optionality afforded to us by our ownership interest in the DTA terminal as we navigate through the tragedy of the Francis Scott Key Bridge collapse at the Port of Baltimore.

While the closure of the port should not have any impact on production in our mine, it’s likely constrained second quarter coal shipments somewhat and in turn dampened Q2 capital returns. However, we expect the impacts to be timing-related, if the Port of Baltimore reopens as anticipated, but the effective cash flow is merely delay rather than loss. In closing, let me say in many respects, Arch is built for periods such as this, where our low-cost position and high-quality products afford us the ability to generate substantial cash flow despite softer market environments. At the same time, we believe we are equally well-positioned to capitalize on the situation and bring even more robust amounts of cash to our shareholders when the markets recover.

With that, I’ll turn the call over to John Drexler for further discussion on operational performance in Q1. John?

John Drexler: Thanks, Paul, and good morning, everyone. As Paul just discussed, the Arch team successfully navigated through significant disruptions to logistics chain in a weakening market environment during Q1, while still delivering substantial amounts of discretionary cash flow. While production levels for our core metallurgical segment were less than ratable from an annual guidance perspective, the portfolio is currently transitioning into increasingly favorable geologic conditions, and we expect good momentum as we progress through the year. In the first quarter, our four metallurgical segments once again delivered a first quartile cost performance and generated nearly $130 million in adjusted EBITDA despite less than ratable output stemming from longwall moves at both Leer and Leer South, typical geologic variability and issues I would characterize as just minor.

We’ve included in this latter category, we lost seven days of longwall production at the Leer mine during Q1 at an estimated impact of around 70,000 tons due to our efforts to coordinate the longwall startup with the local utilities relocation of power lines that were to be under while the steps we took on that front resulted in our receipt of a $9.1 million payment, which was recorded as other income. We estimate that the lost tonnage inflated our Q1 metallurgical segment costs by close to $2 per ton. Even with that impact, the segment’s average cash cost came in at $94 per ton, which was modestly above the high end of our full year guidance range, but still top tier when compared to other U.S. coking coal producers. As indicated, our coking coal mines are transitioning into increasingly favorable geology, and as a result we remain comfortable with our full year guidance and the cash cost midpoint of $89.50 per ton.

In the thermal segment, the West Elk mine continued to operate efficiently and generated solid adjusted EBITDA even as it continued to ship under several legacy contracts that dampened netbacks there. The Powder River Basin assets also operated efficiently, but lost cash in spite of that fact due to the rapidly cooling domestic thermal demand environment. In short, we ended the year stripping at a pace consistent with a 55 million ton per year sales volume level, but currently anticipating 2024 shipments that could be as much as 10 million tons lower than that. As a result, the PRB operated in the Red in Q1, counterbalancing the solid performance at West Elk. On a more positive note, we expect to capitalize on the excess stripping completed in the PRB in the year’s back half and, as in the past to preserve value by negotiating additional out-year commitments in exchange for any customer-requested deferrals.

Looking ahead, we continue to be encouraged by the general progression of our coking coal operations. Leer South is currently operating at a good productive pace and is well on track in our view, to achieve the 3 million ton annual production figure we have targeted for the mine for 2024. Moreover, the development work we are currently doing in district two is serving to reinforce our confidence in the much advanced geologic conditions we expect to encounter there. As previously discussed, our drilling data, as well as our experience via the early development work in that district suggests a materially thicker coal seam and more favorable credibility overall in district two, which would prove beneficial when we begin longwall mining there in the fourth quarter.

I will say again, at a time when many other operations are wrestling with the migration to less advantageous and higher cost reserves, we are fortunate to be moving in the opposite direction of Jerusalem. Now, let’s spend a few minutes discussing the closing of the shipping channel at Baltimore following the tragic bridge collapse there. As we have discussed, we typically ship the majority of our Leer and Leer South export volumes, and roughly half of our coking coal volumes overall via the Curtis Bay Terminal in Baltimore. With the channel closed, we are having to direct volumes elsewhere, and I’m pleased to report that the team is doing a terrific job on that front and remains focused on maximizing our shipments using alternative routes. Of course, our strategic investment in Dominion Terminal Associates in Newport News has been pivotal to our success on that front.

But that has been the great support we have received from our mail firm. While we continue to work around capacity constraints at DTA, we believe we will be able to achieve sales volumes in the range of 1.9 million to 2.2 million tons in Q2, depending on the exact timing of the channel reopening that is currently projected for the end of May according to the U.S. Army Corps of Engineers. That volume level would put us at around 4 million tons through the first two quarters, suggesting a little over a 2.4 million ton quarterly run rate in the year’s back end. Given our available alternative logistics and stockpile capacity, we do not expect any impact to our production levels at the mines due to the port outage and continue to view our prior volume guidance of 8.6 million to 9 million tons as achievable.

Before passing the baton to Matt, let’s spend a few minutes discussing the team’s exemplary achievements in the sustainability arena. As you know, we firmly believe that a culture of safety and environmental stewardship is essential for long-term success in our business. During Q1, Arch’s subsidiary operations achieved an aggregate total lost time incident rate of 0.62 incidents per 200,000 employee hours worked, which was more than three times better than the industry average. On the environmental front, the company again recorded zero environmental violations under SMCRA, as well as zero water quality exceedances across all of our subsidiary operations. Highlighting the team’s excellent work, the state of West Virginia recently named the Leer and Leer South Mines co-recipients of the Governor’s Milestone of Safety award, the state’s highest safety honor.

In addition, the Mountain Laurel mine and the Leer, Leer South, and Mountain Laurel preparation plants were each honored with a Mountaineer Guardian Award for safety excellence. In the environmental arena, Leer South claimed the Greenlands Award, the state’s highest honor for environmental achievement, and Leer and Leer South were honored with additional environmental excellence. On behalf of the Board and the Senior Management team, I want to commend the entire workforce for their deep commitment to excellence in these essential areas of performance. With that, I will now turn the call over to Matt for some additional color on our financial results. Matt?

Matthew Giljum: Thanks, John. Good morning, everyone. Let’s begin with a discussion of first quarter cash flows and liquidity. Operating cash flow totaled $128 million in Q1, which included a working capital benefit of $19.7 million. While we had anticipated working capital to build in the period, the decline in metallurgical prices over the course of the quarter, combined with lower thermal shipping volumes, resulted in a meaningful drawdown of accounts receivable. Capital spending totaled $45 million and discretionary cash flow was $83 million. Turning to the balance sheet, we ended March with cash and short-term investments of $340 million, essentially flat with 12/31 levels. As we discussed in last quarter’s call, we closed on our new $20 million term loan in Q1 and largely used those proceeds to retire the old loan and make other debt amortization payments, resulting in the end-of-quarter debt $146 million, which was only modestly higher than year-end levels.

Our net cash position was $174 million on March 31st and our liquidity was $442 million, both of which remain above target levels. Turning now to the capital return program. We continue to execute on our two-pronged approach, systematically reducing the share count while also paying a meaningful dividend. Starting with the share count. Through a combination of the capped call unwind and share repurchases, we retired 410,000 shares during the quarter. The capped call unwind, which made up over 75% of that total, was equivalent to a share repurchase of nearly $53 million, but without any cash outlay in the quarter. We also repurchased 95,000 shares in the open market in Q1 and in total have now retired over 2.5 million shares at an average price of $139 since we relaunched the program.

That combined with the retirement of the convertible debt has reduced our fully diluted share count by 3.5 million shares since its recent high point in 2022. While share count reduction is our clear priority, the dividend remains a significant component of Arch’s value proposition. The Board has approved a quarterly dividend of $1.11 per share today, bringing the total dividends to nearly $39 per share since the beginning of 2022. The upcoming dividend will be paid on June 14 to stockholders of record as of May 31st. Next, I wanted to provide some additional detail around Paul’s comment on Q2 capital returns. John just provided an excellent overview of our approach to managing our export metallurgical shipments, while the Baltimore harbor remains closed.

From a timing standpoint, as you would expect, much of April to date has been focused on redirecting activity away from Curtis Bay into DTA and other alternatives, with the net result being export shipments heavily weighted toward the latter half of the quarter. Additionally, we expect a further seasonal step down in thermal volumes in Q2 before seeing modest improvement as we get into the summer. As a result, we currently expect a significant working capital increase in Q2 and that operating cash flows and discretionary cash flows will be at levels that won’t allow for significant share repurchases in the quarter. We view this strictly as a timing issue, and we anticipate cash flows and capital returns to normalize as we get to Q3. As a final point, while we expect second quarter volumes in both segments to be lower than ratable as compared to guidance levels, we expect stronger performance in the second half of the year and are maintaining our full year operating and financial guidance.

With that, we are ready to take questions. Operator, I will turn the call back over to you.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from Lucas Pipes from B. Riley Securities. Please ask your question.

Lucas Pipes: Thank you very much, operator. Good morning, everyone. I want to start with a strategic question. So when I kind of think back over the last couple of years, there were a number of kind of unexpected issues the Curtis Bay disruption, West Elk, Geology, Leer South Geology. And then obviously, at the recent tragedy in Baltimore. Your strategy has been focused on kind of large productive minds, and you focused on these core assets. And I would expect mean reversion kind of from the events of the recent years. But is there a case to be made in how do you think about adding more geographic or other diversification to the portfolio? Thank you.

Paul Lang: I think it’s an interesting question because I think, I’ve told people many times over the years, I think back 2012 when we were operating 38 mines for us we found it was not the easiest thing to do. I think there’s others that are, that do it well. Where we have found our sweet spot, I think, is operating very large, very efficient, very low-cost mines, and it does come with a certain degree of exposure. But by and large, I think is – particularly as we continue to improve things, where start I think we really will be set up well going into the future. I think, more importantly, what you’ll see is that if you look at our maintenance CapEx being status quo over the next ten years, our CapEx is going to be much lower than some of our peers on operating lines. That’s a little bit of the offset to the very issue you’re talking about being more spread out. So with that, I don’t know if any of the others have any thoughts on that.

Matthew Giljum: So Lucas with that as start, and so with the addition of Leer South, obviously, you know, we were endeavoring to address just that, and I think we’ve done that to a meaningful degree. Of course, it’s not going to be perfect diversification, but to a meaningful degree. And I think DTA underscores what you just described, which is the investment we made to expand our investment, actually, at DTA several years ago, is really paying dividends today. So we certainly are aware of that need to make sure that we have flexibility, that we can be nimble, that we do have alternate routes and multiple production sources that are consequential. We have two big horses now, rather than just one in the coking coal segment as an example.

So we have taken meaningful strides. Again, I think that’s paying dividends significantly right now when you think about how much volume we expect to move in Q2, despite the fact that Curtis Bay is right now out of the market. So, but good comments.

Lucas Pipes: Thank you very much for those comments. On the thermal side, it looked like you restripped quite a bit in the PRB given the market conditions. So for Q2, what would you expect this to mean on the cost side? I’d assume there’d be a pretty sharp reversal. So if you could kind of walk through the implications on the cost side, also on the volume side for Q2? I would appreciate that. And then, Matt, I think you mentioned there at the end of your comments that working capital will be used in Q2, and you’d expect that to reverse later in the year. You have been very tactical in the past with the pursuit of share repurchases. Could this be a period right now where, even though cash flows may be temporarily restricted, you continue to lean in, given your very bullish long-term outlook on met coal prices? Thank you very much.

John Drexler: Lucas, it’s John Drexler here. I’ll start out with a discussion on the thermal side. The PRB, as we described in our prepared remarks, you know, the team there had prepared for a stripping level that was meaningfully above what we’ve seen here, start to play out at the beginning of the year, obviously, the winter was less than ideal. We’ve seen gas prices that are displacing electric generation from coal. Just a lot of pressures, and everybody has been feeling it there. What I’m real proud of is the team out at and PRB does a fabulous job. They’ve been through this before. They know what to do. Unfortunately, it’s not something that just happens overnight. They’re in the process right now of adjusting schedules, eliminating overtime, managing headcount, laying down equipment, doing all of the things that we’ve done and we’ve done successfully in the past, but it typically takes several quarters.

As we discussed, we have created some pit inventory. We stripped higher than what was shipped. As we realign the operation moving forward, we’ll get that benefit. We’ve seen 50% growth essentially in our pit inventory that we’ll benefit from in future quarters. But as you look at the second quarter, from a seasonality perspective, there’s typically a lot of pressure in that historically in Q2 anyway, because of spring in the shorter season. So Q2 may be another challenging one as well. But the team right now is actively implementing all of the measures that we’ve done successfully in the past. We’ll be working to control those costs, minimizing the negative impact in Q2, and we’ll expect to benefit from that and get back to cash positive here as we work through the remainder of the year in 2024.

Paul Lang: And Lucas, in the past, if you look back, you can certainly see those periods when we do sort of flip over to shipping more than we strip, you can see the margin expansion. Now, obviously, there’s some headwinds out there on the thermal side, stockpiles are very high, gas prices are low. So we’ll see how that manifests itself. But that can be pretty powerful when we do move to that point where we are shipping more than we strip, as opposed to the headwind that we’ve had in Q1, we’ll have again in Q2, which is stripping more than we ship. So certainly are feeling optimistic about the second half, but we’ll also have to watch and see what happens with thermal demand overall.

Matthew Giljum: Lucas, on your question regarding the share repurchases, what we clearly expect a working capital build this quarter better to predict this quarter probably than most, just given all the uncertainties around how the export shipments will be diverted and where those will end up. But safe to say, given the shift in volumes to the latter half of the quarter, that we’ll see that build. As it relates to the share repurchase program, we clearly last quarter built up a nice bit of cash on our balance sheet to be opportunistic, and if the share price moves in a way that we think it’s very opportunistic to be in the market this quarter, I think you’ll see that. But clearly, that was meant to be for times when the cycle really moved against us, when the long-term fundamentals didn’t necessarily do so. So I think we’d probably be more likely to continue to hold that cash absent a particularly good opportunity for buybacks.

Lucas Pipes: Thank you very much for all of your color. Continue best of luck. Thank you.

Paul Lang: Thank you, Lucas

Operator: Your next question comes from the line of Nathan Martin from Benchmark Company. Please ask your question.

Nathan Martin: Hi, good morning, guys. Thanks, operator.

Paul Lang: Good morning, Nat.

Nathan Martin: Just maybe sticking with the thermal segment just real quick. I mean, obviously, you guys just highlighted the high stockpiles, low natural gas prices, mile the winner for the most part. So what gives you the confidence that you can still hit your full year thermal shipment guidance targets? How are conversations going with customers, maybe I think previously you mentioned we could see another 5% to 10% of those contracted tons roll over into 2025. And then, you know, maybe separately, you highlighted another negative contribution in the PRB, likely for the second quarter. But is there an opportunity to have an overall positive contribution from the segment, that thermal segment based on how you think West Elk will perform?

John Drexler: Nathan, the goal here, and obviously we believe over the course of the year we are going to have the thermal segment cash-positive position both West Elk and in the PRB as we move forward. We talked about this on the last call. We talked about it in prepared remarks. We are essentially committed in the PRB to higher levels than what we are indicating in the thermal shipment levels. And the expectation is that we are going to continue to see pushback. I applaud the marketing team and their efforts to manage that. When you have essentially, you know, significantly high stockpiles, the inability of utilities to take any more coal, you know, we found ways and opportunities here to roll over tons, not just to preserve value of those tons that are rolling over, but to actually create value as well.

We did that successfully in 2023 and the team’s already focused on that and working through those types of opportunities as we move forward here. So, yes, we could see, you know, ongoing pressure. We could see, you know, shipments continue to be challenged. But once again, with the work that’s being done to help the operation to realign for the expected shipment levels moving forward and the work that the marketing team is doing, we do expect to get it back to cash positive as we get to the back half of the year.

Paul Lang: Hi, Nick, this is Paul. Look, I think one thing that gives me comfort is I look back, John and the team at the Powder River Basin have just done an amazing job last five, six years of responding to the market up and down. There was big buying [60 billion] tons of your mine doesn’t change overnight. In this case, we’ve done a very good job over the years responding to these changes in market. And of all the locations that would have to do it, Black Thunder would be the one I would pick. And I think they’ll do a very good job.

Matthew Giljum: And then just on the granularity of the numbers, look at, you know, right now we could foresee potentially shipping as low as 45 million tons out of the PRB when we add 4 million tons at West Elk and the thermal byproduct needs, and you’re looking at 50 million, which is the low end of that range. Again, we may ship more than that, but right now we continue to see value in working with customers, deferring shipments if they need to defer them, and then using that to get some link, you know, in an environment where stockpiles are very high out there, getting sort of out of your business could be challenging, but seeing this opportunity to work with customers to get length and maybe multiples of volumes in terms of if we defer one time, potentially getting additional volume beyond that one time in out-years is a real opportunity.

So we are going to be strategic about it. But I do think the $50 million to $56 million tons encompasses a reasonable range for what we would expect in almost anything.

Nathan Martin: Appreciate all the color there, guys. Maybe shifting over to the Met segment. John, I know you touched on some of this in your prepared remarks, but clearly, Leer had a weak production quarter, I think one of the weakest in five-plus years. So do you expect that to kind of return to the typical, call it 1 million ton per quarter kind of run rate post the power line relocation you mentioned? I believe you also previously said the mine should be moving into thicker scenes. So great to get a little more color there. And then related, how should we think about the second quarter Met segment cost per ton, at least directionally, from the first quarter? It seems like if we remove that $2 per ton from the power line relocation that you called out, maybe things should improve, but would be great to get your thoughts.

John Drexler: Yes, good questions. We’ll start with Leer and some of the commentary around that. The power line relocation came at the end of a longwall move. We have the right to subside the panels that we mine. There was power line towers that came across that the local utility requested that they wanted a little more time to shore up those towers. We were compensated for that $9.1 million that we recorded, another income. But clearly delaying the startup of the longwall is impactful 70,000 tons, $2 a ton impact for us as we move forward. We describe other things as well. You can have geologic variability, you know, the end of the day, immaterial in the grand scheme of things. So you might have had an impact or two, a few things there.

Those are all things that we manage each and every day and don’t expect any longer-term impact. So yes, absolutely, we are confident Leer is going to get back on track. It is going to be heading into some different coal and the panels that it’s going to continue to mine here for the remainder of ’24. We touched on Leer South as well. It went through a move also all of the teams do a fantastic job with the longwall moves. We don’t typically end up talking much about them, but it was a little bit of an impact for Leer South. But once again, the opportunity that Leer South is as we transition out of district one and into district two in the beginning of the fourth quarter of this year, we’re going to see immediately improved coal seam thickness, somewhere in the range of 15% to 20% thicker than what we’ve experienced here since the longwall started in district one.

So we feel real good about that moving forward. So, once again, we’ll manage through that and expect volumes to improve as we go forward. Related to costs, obviously, you’re impacted by the volume. So we expect improvement in the cost as we move forward into Q2. We would expect somewhere, you know, getting back into the mid-80s, like $86 a ton type ranges as we go forward according to our plans moving forward.