Q1 2022 Arch Resources Inc Earnings Call
Ladies and gentlemen, you are currently on hold for today's conference call. At this time, we're sending today's audience and plan to be underway. Shortly thank you for your patience and please remain on the line.
[music].
Good day and welcome to the Arch Resources, Inc. First quarter 2022 earnings Conference call. Today's conference is being recorded I would now like to turn the call over to deck Slone Senior Vice president of strategy.
Good morning from St. Louis and thanks for joining us today.
Four we began 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 file 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 have posted in the investors section of our website at arch RFC Dot com.
Also participating on this morning's call will be Paul Lang, our CEO , John Drexler, our C O O and Matt Gili our CFO .
After our formal remarks, we'll be happy to take your questions with that I'll now turn the call over to Paul Paul.
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 quarter just ended the Rx team once again executed at a high level delivering record earnings despite the pervasive drag or rail related challenges. It was our second straight quarter of record earnings and more importantly, a quarter of significant progress against each of our key strategic priorities.
Among the highlights arch achieved a record gross margin in our core metallurgical segment repaid more than $280 million of indebtedness and restored the balance sheet to a net debt neutral position reached.
It reached $100 million are almost 80% of the targeted balance in our thermal mine reclamation fund, putting us well along the path towards completing this effort by July .
And finally announced a second quarter dividend more than a $135 million or $8 11 per share payable in June .
While these are all significant event I think the relaunch of the capital return program deserve particular focus because it signals that inflection point in the evolution of <unk> long term value proposition.
As you know we have viewed a robust capital return program is a central tenet of our long term strategy for creating shareholder value.
Toward that end, we launched the initial phase of our capital return program in May 2017 hit pause on that program in early 2020 at the start of Covid in order to drive forward with the construction of a more powerful cash generating portfolio through the build out of Leer south.
Italy, we relaunched the new program in February 2020 to less than six months after the commissioning of the Leer South longwall.
Today, we demonstrated just how powerful the combination of our upgraded operating portfolio and our new capital allocation model or by announcing the first substantial dividend under the new program.
We realize it's atypical for a company to commit to returning effectively 100% of its discretionary cash flow to shareholders, but it's also atypical for a company with our cash generating capabilities to have such a modest cash requirements going forward.
In short we've now accomplished what we set out to achieve when we initiated our strategic pivot more than 10 years ago.
We have a world class coking coal portfolio that is well positioned to compete on the world stage for decades to come.
We have a legacy thermal segment that generate significant levels of cash requires very little capital and can be systematically wound down in a responsible manner.
And just as importantly, we have a well fortified balance sheet with as much cash as debt effectively no refinancing risks as well as a newly constructed asset in the form of our thermal mine reclamation funds that counterbalances the principal concern associated with these operations.
When we made the decision to move forward with the build out of Leer South back in February 2019, we've made it clear that we plan to enhance the capital return program once that project came online.
Consequently, the board views, our new capital return model is making good on that commitment and more broadly rewarding the shareholders for their years of support during our strategic pivot towards steel and metallurgical products.
Before passing the call to John I'd like to share a few thoughts on the coking coal markets, which remain at historically high levels at.
At present arches primary metallurgical product high vol. A coal is being assessed at $470 per metric ton on the U S East coast, which needless to say translates into attractive netback for our low cost and highly competitive coking coal operations.
As we've repeatedly said in the past, though markets work and thus we don't expect these elevated prices to last indefinitely.
We do however continue to view coking coal markets as fundamentally well supported.
Of course, the macro environment is complex at present.
Due in large part due to disrupted trade flows stemming from hostilities in Europe , coupled with the Chinese importation band of Australian calls even with this steel continues to trade at highly profitable price levels in both Europe , and North America and the outlook for steel markets in Asia is positive.
Gnomic development remains a sharp focus steel intensive stimulus efforts are underway and the build out of new integrated steel capacity has resumed in India as well as other parts of southeast Asia.
Even more significantly coking coal supplies remained persistently constrained exports from Australia, the United States and Canada are under shooting in 2021 levels year to date and lagging pre pandemic levels, even more dramatically.
As we've noted many times in the past the industry is feeling the effects of years of Underinvestment and the pipeline of new coking coal projects remains light.
While a protracted period of high prices could ultimately prove the remedy for such under investment capacity additions require long lead times have yet to get underway in any meaningful fashion.
At the same time the maturity of the existing mining operations continues to take its predictable coal.
Along with this current strong seaborne thermal demand and elevated prices are also acting to support coking coal markets.
Thermal coal is currently trading at prices of about $300 per metric ton in both the Pacific and Atlantic basins, which is which is acting to pull lower quality coking coals into the thermal markets.
Such crossover volumes are further pressuring it already strained in seaborne coking coal supply and demand balance.
Yes.
Looking ahead to the second quarter, we anticipate a significant step up in our financial results given the current pricing levels across all our products in conjunction with an expected increase in coking coal volumes as rail service continues to slowly recover.
Additionally, we expect further strengthen our results in the back half of the year as shipment levels returned to normal and we have the chance to monetize our currently large and highly valuable coking coal inventories.
The most important takeaway however is that all of these positive catalysts in aggregate should translate into high levels of discretionary cash flow and thus high levels of capital return for our shareholders as the year progresses.
So today the art story is by design a relatively simple one.
We've developed a world class metallurgical asset base with a premium high vol, a product slate.
<unk> and industry, leading ESG performance and cultivated top tier marketing and logistics expertise.
On the strength of these attributes in keeping with our clear and well defined strategy. We believe we're in an excellent position to generate substantial long term value for our shareholders through the deployment of our new capital return program. While at the same time positioning the company to capitalize a renewed global economic development and the <unk>.
Transition to a low carbon economy.
With that I'll turn the call over to John Drexler for further details on our operational and marketing performance John .
Thanks, Paul and good morning, everyone.
As Paul just discussed the arch team maintained excellent momentum during the quarter just ended delivering yet another record setting earnings performance and driving tremendous progress on our key strategic priorities.
Perhaps most impressively the team accomplished all of this while managing through poor rail service widespread inflationary pressures and higher sale sensitive costs.
As I've stated in the past arch is fortunate to have such a high performing workforce. The team continues to prove that it is well equipped to adjust to almost any eventuality and poised to carry the organization to even greater heights in the future.
Let's turn now to our operating performance.
As indicated our core metallurgical segment delivered exceptional results. Despite a range of cost related pressures anemic real service chief among them.
Despite a nearly 25% decline in coking coal shipments quarter over quarter. The team was still able to hold unit costs relatively stable.
That's particularly noteworthy when you consider that the average sales price for our coking coal volumes increased by more than $63 per ton or approximately 30%.
Which in turn drove a nearly $5 per ton increase in our sales sensitive costs.
In addition, inflationary pressures continue to Mount during the quarter driving up the cost of materials supplies and consumables in areas ranging from labor to equipment parts to roof control products.
While the team continues to do an excellent job of managing the impact of these cost pressures they are real and likely to be with us for a while.
Before moving on to our legacy thermal segment, let me spend a few minutes on the single biggest challenge we faced during the quarter, which was inadequate rail service.
To give you a sense of the magnitude of the issue. We only received approximately 60% of the trains we needed during the quarter.
Well there was progress over the course of the quarter, we received less than half of the trains we needed to match production levels in January 60% of the trains we needed in February and.
And approaching 70% of the trains we needed in March.
The upshot of this poor rail service was a significant shortfall in our normalized coking coal shipments in Q1, along with the stockpile stockpile build to nearly 1 million tons during the period.
While all of that high quality coking coal now constitutes a highly valuable asset for the company, particularly in today's coking coal market environment.
It's a far from optimal situation.
Somewhat encouragingly, we have indeed seen modest incremental improvement in April when compared to March and are now receiving approximately 80% of the trains we would typically expect.
But that means we're still adding coking coal to already swollen stockpiles.
To stabilize at current stockpile levels, our coking coal mines need to load around 75 trains per month, which is consistent with their $2 5 million ton per quarter productive capacity.
In order to begin to draw down and monetize existing stockpile levels, we need something north of that 75 trains per month figure.
That's entirely doable on are in mind, you. We can load of 100 car unit train and around four hours at each of our mines, which means we can accommodate multiple trains per day at each of our mines.
But we need for the railroads to prove its also doable on their end and of course Theres No reason why it shouldn't be.
As indicated we are guiding to a 50% increase in shipment levels in Q2, when compared to Q1, which anticipates incremental improvement in service as the quarter progresses.
But which is still shy of our actual productive capacity and long term needs.
Let's transition now to our legacy thermal assets, which continue to benefit from a very significant book of contract business as well as a highly attractive export market environment.
In Q1, the thermal segment generated more than $100 million and segment level EBITDA, while expanding approximately $4 million in capex.
That means that since launching our harvest strategy five and a half years ago. We have now generated an aggregate total of more than $1 billion from these assets, while expanding just $114 million in capital.
Or to put another way, we generated nearly nine times more cash than we've expanded and we expect more of the same as we progress throughout 2022 and beyond.
We view that as hugely value, creating for our shareholders.
Now, let's shift our focus to the marketplace as Paul discussed global coking coal markets continue to be impacted by a combination of solid steel market fundamentals.
And persistent and perhaps even structural supply constraints.
These global market fundamentals are helping arches financial performance as we would expect.
During the first quarter as I mentioned earlier, we captured an average coking coal price at the mine of nearly $270 per ton.
As we discussed on the last earnings call. There were approximately 200000 tons of lower priced coking coal shipments committed in early 2021 for Q2 2021 through Q1 2022 delivery the European steel year.
When you factor in those tons you can see that we were securing for the remaining tons prices fully reflective of prevailing price indices and assessments.
It's also worth noting that we committed incremental north American sales volumes during the quarter as well at a fixed price well in line with the 2022 price curve.
I am pleased to report that we were rewarded for our patients.
Logistical flexibility and.
Our significant geographic market reach in securing this attractive business.
Uh huh.
Yes.
Let me also take a moment to highlight yet again the tremendous asset we created in 2021, when we built out our thermal contract book for 2022, 2023 and beyond at highly attractive prices.
As indicated in our guidance table, we have a committed and priced position of $77 9 million tons of thermal business for delivery in 2022.
At an average price per ton of $17 96.
Included in our committed position is nearly $3 5 million tons of thermal coal, we expect to ship into the export market. During 2022, both from Black Thunder and West Elm, which given current market conditions should average up that price significantly.
While we arent ready to share details about our 2023 contract position I will say that we have a very solid foundation in place at prices that will not while not yet reaching 2022 pricing levels are well above historical averages.
Moreover, we currently expect 5% to 10% of our 2022 volumes to roll into 2023, given western rail struggles.
And those rollover tons should serve to further boost our 2023 contract position in terms of both volume and price.
Finally, I want to highlight the work we continue to do to ensure that orange maintains its well established position as an industry leader in the ESG Arena.
As you know arch has set the standard in mine safety among large integrated coal producers for some two decades now and we continue to view behavior based safety as the centerpiece of our corporate culture.
That deepen overarching value was evident yet again in April as the state of West Virginia bestowed our metallurgical operations with a total of four Mountaineer Guardian awards for safety Excellence.
Similarly, the team's tremendous focus on environmental stewardship was also on full display during the quarter as we secured two awards for reclamation excellence.
We are tremendously proud of these honors and view them as emblematic of arches overall commitment to excellence across the full range of ESG metrics.
Yes.
With that I will turn the call over to Matt for thoughts on our financial performance.
Thanks, John and good morning, everyone.
For the second straight quarter, we were reporting record earnings with net income earnings per share metallurgical segment margins and EBITDA all at new highs.
In addition, operating cash flows for the quarter were also at record levels and essentially double the fourth quarter level.
Getting further into the detail operating cash flows totaled $293 million, even as inventories grew by nearly $50 million as a result of the poor rail service and.
And as we contributed $20 million into our thermal reclamation fund.
Capital spending was just $22 million in the quarter as Q1 will be our lowest capex quarter of the year.
This results in discretionary cash flow for the quarter as we've defined it of just over $270 million.
As we discussed in last quarter's call, we prioritize debt reduction in Q1 <unk>.
Repaying over $280 million of our term loan and other indebtedness over the course of the quarter and.
And decreasing our total debt to $323 million.
Taking into account our cash balance of $319 million, we delivered on our objective of returning our balance sheet to a net debt neutral position.
Total liquidity at March 31 was $386 million, including cash on hand, and availability under our credit facilities.
We continue to view this level of liquidity is appropriate in light of the volatility of our markets and geopolitical and macroeconomic uncertainties.
Next I'd like to add a bit more detail around our thermal segment reclamation fund.
As we previously discussed we broadened our focus late in 2021 from the accelerated reclamation work at coal Creek to include pre funding future reclamation, primarily for Black Thunder.
That funding began in the fourth quarter with the contribution of $20 million and we match that in the first quarter.
In light of our strong thermal cash flows and the continued positive market conditions. We have already contributed an additional $60 million in April .
The total fun to $100 million.
Our plan is for the fund to match the Black Thunder asset retirement obligation liability on our balance sheet.
Currently that liability is approximately $130 million and we would expect the fund to reach that level early in the third quarter.
Going forward, we would expect to keep the fund at the level of the arrow, increasing with the ongoing accretion of the liability, but offset by reclamation work is completed.
In any event, we would expect additional contributions after the third quarter to be no more than $5 million quarterly.
Finally, as a reminder, we expect to draw money from the fund as we complete final reclamation at Black Thunder several years from now.
Over the past two quarters, we have meaningfully strengthened our balance sheet and reduce risk something we view as necessary for long term success in our industry.
In the more immediate term we are now positioned to resume meaningful capital returns with the first variable dividend under our new return program.
The board has approved a second quarter dividend of $8 11 per share, which was determined based on 50% of our first quarter discretionary cash flow.
The dividend will be paid on June 15th to stockholders of record on May 31.
Regarding the other 50% of the program, we expect that to begin in earnest in the latter half of this quarter subject to board approval as debt and liability reduction had been our priority thus far.
Turning back to the quarterly financial results earnings for the quarter included a mark to market loss of $15 $5 million associated with our KOL hedging activities.
Net losses related to hedges that we have in place for planned thermal exports over the remainder of 2022.
And we expect the mark to market losses to reverse as the hedge positions settle.
Our hedging strategy is to lock in attractive prices and margins for a portion of our planned export shipments while continuing to have exposure to the market.
It is also important to note in today's volatile markets that these hedges are not subject to margin requirements and as such the cash flow impact of the hedges will be closely aligned with the actual sales.
Briefly turning to our outlook, although rail service remains a challenge across our business. We expect increased coking coal sales volumes in the second quarter.
That improvement along with continued high prices should result in even stronger financial performance and cash generation in the second quarter and the opportunity for significantly increased capital returns.
With that we're ready to take questions operator, I will turn the call back over to you.
Thank you if you'd like to ask a question at this time, please signal by pressing star one on your telephone keypad. Please ensure the meat function on your telephone is switched off to allow your signal to reach our equipment again. It is star one to ask a question. We can take our first question now from David Gagliano of BMO capital markets. Please go ahead.
Okay. Thanks for taking my questions, obviously, there's quite a bit to dig into here.
I guess.
A couple of clarification questions from from my side first of all.
The order on the thermal commentary.
It was mentioned three and a half million tons that are going into the export market I just want to clarify is that included in the $77 9 million committed and the $17 96 per ton price or is that.
Different.
David This is John Drexler, the export opportunity that we have for both.
Our black Thunder and West Dock operation is significant so that constitutes the $3 5 million tons. It is all incorporated into the overall guidance of our commitments. Some of that export volume is is is not priced obviously, it's floating with where market indices are and that will provide us an opportunity very attractive net backs.
Both of the operations, so I hope that clarifies a little bit of what's included in the in the guidance.
Well it does a little bit, but yeah, that's exactly where I was going with that I. Appreciate the color. How much is not included and and yes, I'm trying to figure out that $17 96 price how much of that is.
Volume is included there.
So Dave what would be included in there would really be what shipped in the first quarter and then a small amount of additional hedge position for the rest of the year, but the lion's share of it is not reflected in that in that number. So clearly there's some upside to that realization as the year rolls on at these prices you know the Paul quoted earlier.
Stay as strong as they are for both on the on the Atlantic side as well as on the on the Pacific side, Dave in the guidance the committed and unpriced that $2 5 million tons. That's a good reflection of a lot of that being the export opportunity.
Okay understood. Thanks, and then just switching over to the the cash cost guidance, obviously for the year, it's much lower than Q1, obviously makes sense given the volumes are increasing I just have a multi part question on this one here, what's a reasonable assumption for two Q met cash costs.
And what's the met price assumption for 2022 cash cost guide.
And then lastly is that relationship that you mentioned earlier, you know $63 per ton price increase resulted in a $5 cash cost increase is that a reasonable rule of thumb.
For overall price sensitivity to cost changes moving forward. Those are those are my cost questions.
So David good questions I'll make sure if anybody if I don't hit them all make sure we come back to them for somebody to step in and make sure we get them all answered.
From the cost kind of cadence for the quarters once again.
We're encouraged that we're seeing an improvement in volumes and we've guided up 50% in volumes from the first quarter, but it's still going to be below what we need on a regular run rate basis. So once again as you look over the course of the year, Yes, we do expect a step down in unit costs as reflected in our guidance but.
Our second quarter volumes are still going to be below where we would ideally like them to be so maybe that gives you an indication that the expectation would be cost could still be elevated during the second quarter as well.
As far as the increase in the sale sensitive cost one of the real opportunities that we have is the majority of the mineral reserves that were mining on into the met segment. Our owned in fee. So we don't have royalty expenses associated with them. So we've typically guided kind of in a 6% to 8%.
Royalty, our sales sensitive cost range for sale.
Sales in our met segment and so I think that's kind of reflective of the guidance that we just indicated a $5 per ton sale sensitive cost increase on the $63 increase in realization. So hopefully that makes sense and if I missed any of the questions.
David I'd say, it's deck again look I would say that that that's a complex question as to what is sort of assumed from a pricing perspective, because obviously, there's some backwardation in the market etcetera, but the range, we provide doesn't caps encapsulate a range of different prices as well. So obviously, if the prices stay as strong as they are.
Or are you would expect it to be higher in that range and now having said that clearly it suggests that we could have much lower cost in the second half.
And then we had in the first and as John said, we would expect see some improvement in the second quarter on this coking coal cost, but again still a high priced environment and again still volumes being constrained, but in the second half of the year with the volumes that are that are intimated by the by the you know the guidance for what we provide.
For guidance of the $9 4 million tons at the midpoint that certainly suggests that if we're shipping it to a $2 9 million tons per quarter in the second half, we should get significant benefit from that higher volume.
Yeah, David the only last piece of color I would add is that when you look at the east or excuse me look at the west.
Remember our sales sensitive runs about 30 or 35% so.
When we talk about these higher export prices Thats one of the things that's really pushing the cost up in the west and I think leads to your question on the impact of some of these higher prices.
Okay. That's helpful. Thank you very much for that detail and then just the last one for me for now just on the capital returns obviously.
Nice start to the harvest mode.
And then more to go just on the other 50% I believe there was a comment made during the prepared remarks that the other 50% execution on the other 50% would start later into Q.
Can you expand on that comment what is.
I think in the past, it's mostly been about buybacks is there anything else.
Other than buybacks that we should be thinking about now that the debt is reduced now that the surety bond fund is effectively funded our almost funded is there anything else, we should be thinking about other than buybacks.
Yeah.
Hey, Dave This is Matt I guess, the just the the other thing that we've talked about obviously, we do have the convertibles outstanding and whether those are something that the board may choose to want to address that as an alternative as well we sort of view that is very akin to a buyback.
Given where the share prices today and the amount of of our in the money that those bonds are so that is another alternative we could do and then we have talked about some level of capital preservation I don't know that that's the priority at the moment, but clearly you know the the buybacks and the converts would be the two logical places that.
We could see the board decided to go.
Okay. That's helpful. Thanks very much.
Thank you Dave Thanks, Ed.
We can now take our next question from Lucas pipes of brands Securities. Please go ahead.
Thank you very much and good morning, gentlemen.
Hello.
I first wanted to touch on rail and logistics and a bit more detail in the prepared remarks, you mentioned that you anticipate rail improvements as the quarter progresses.
What gives you the confidence in that improvement and to what extent.
That's that rely on Curtis Bay getting back up to full capacity. Thank you very much for your perspective on that.
Hey, Lucas great.
Great question, obviously rail performance has been extremely disappointing.
As we've worked through the quarter and it has been our biggest challenges created a host of.
No.
Issues for us to be working through and dealing with however over the course of the quarter as we indicated we have seen improvement.
The month January February March we have been working obviously extremely close with the railroads.
We've seen improvements for some of the commitments they've indicated would be would be coming.
We indicated that through the majority of April here.
Month to date, we're at 80% level. So that just once again continues that improvement as we listen to their earnings call. This is a major focus for them across their network, it's primarily labor.
Crew driven.
It was further impacted very early in the year by Covid, but now what they need is additional crews so.
It appears in the discussions that we're having in the public remarks, they're making they're very committed to getting that crew situation fixed and.
And so we expect ongoing improvement as we work over the course of the year, we'd like to see that improvement sooner, but obviously any crude that comes on needs to go through an extensive training program brought online.
So you know we are shaping our views appropriately as we work through the course of the quarter, but we've got high confidence that the rails will execute their incentive to execute with us in this environment, a great opportunity for them to move the call.
And so we expect that to improve as we move forward.
And look as is as as John pointed out look in January we've got about a third of the trains we needed in February about 50% and in March around 75%. So around 70%. So a part of it is just trajectory and clearly we're not expecting them to get all the way back in Q2, So we hope we're being reasonable here in our assumptions.
But you're right, we certainly don't have control over at you.
You did ask about Curtis Bay, and look we really view this as more of an issue. That's just sort of endemic and it's really a rail system over issue overall, we have not had too much difficulty finding opportunities to get times into vessels. The issue really has been moving the tonnes to the ports. So really it has been a rail issue we don't think it's.
It's specific to Curtis Bay, although we welcome the work that's being done there and we think that will certainly add to overall fluidity on the line, but really it is we believe what John sort of highlighted as sort of overall rail congestion crew issues etcetera and as Curtis Bay continues their repairs.
We are shipping through them at a very reduced capacity and we expect to see improvement.
Curtis Bay, as we move forward, but as Dirk indicated.
We've got plenty of alternative opportunities for export and so not significantly impacted by that immediate issue.
Very helpful really appreciate all the detail.
My second question is first and foremost a market related question.
I'd like to shifted a little bit to the domestic market, we've seen natural gas prices in North America Spike as well.
What sort of impact have you seen on.
Demand for spot volumes.
From domestic utilities.
What have been the implications for 2023.
I believe in the prepared remarks, there was a comment about a significant amount of rollover into 2023, but I didn't catch all of that if you could maybe elaborate on on that as well I would appreciate it. Thank you very much.
Yes, Lucas look in the in the back half of 2021 thermal markets strengthened considerably as we discussed on the last call and is carried through in.
In the first quarter, the marketing team did an outstanding job of capturing that opportunity.
Markets have continued to stay strong you look at where natural gas pricing is at.
It definitely puts a call in the money.
The team continues to have a lot of discussions with our customers.
They are evaluating their needs as they move forward one of the biggest opportunities that we've been able to realize with the strength in the market is not just getting cold put to bed for for 'twenty, two but also in future years as we indicated.
We're not providing guidance yet in those future years, but the book of business is built out well.
The pricing once again in the prepared remarks, and we will.
Being specific.
Specific here is not to the levels that we're seeing for 'twenty, two but well above what the historical averages have been.
Prior to <unk> 22 in those outer years, so we feel real good about that the logistical issues that we've seen in the east are really across all of the rails, including in the west as well so.
We see rail challenges there.
We need those rails to perform at a higher rate.
And so as we look at our book.
We're sold actually above the guidance range that we've provided but our expectation is that we're going to see pushback kind of in that range of 5% to 10% potentially.
That pushed back will allow us to roll those tons into future years, obviously with the pricing that we have right now on those tons in 'twenty two.
That's just fine with us if those roll into <unk>.
<unk> 23, as well so hopefully that gives you some additional color on the markets Lucas I guess I'll I'll step back take kind of a higher view of this a little bit of this is muted by the rail situation, but as.
As you stand back and look at the domestic thermal.
Thermal prices.
Obviously, what's driving it it's high natural gas prices the utility inventories are low, but they are not going out for RFP, because they don't have rail service.
And frankly theres been a slow response for the producers, mostly because that's just due to underinvestment.
And we could argue that the transition to renewables and all of that.
At the same time, we have higher price export options and I think these things collectively have kind of changed the macro environment at least for the short term.
Look as it stack and just let me add a final thought here. So you know obviously, if we do in fact have rail deliverability issues and we lose some of those volumes are they don't get shipped rather in 2022, we're really quite comfortable with that I mean, we got a very significant book of business and so if we do in fact see 5% to 10% roll in 2020.
Three again that that is.
That's a non issue for us as we see it and quite frankly as you look at where we are there and if you assume the 5% to 10% rollover that John discussed, we're getting close to sort of our budgeted volumes for 2023, and what we anticipated what we previously anticipated we would produce in 2023, we don't want to be too granular about that and we certainly do have the ability to.
<unk> up somewhat from that level, but we are building a very strong book of business and in terms of sort of interest look it's only Tuesday, and we've already committed a meaningful volume that did a deal already this week. So there is good appetite out there. These gas prices are getting the attention of the utilities.
While we've seen certainly a lot of closures of coal plants over the years. The remaining fleet is only operating at about 50%. So there is the potential for some of those plants to operate at higher levels and so look we're very attuned to that we continue to take advantage of that market and feel really good about where we are.
Super helpful.
So so if if railroads to improve in the west.
Would you consider raising production volumes.
Well I think the Lucas we raise them above sort of our you know again, we had budgeted at a level that we believe will be very profitable for the organization, we generate a lot of cash.
Certainly today the level, we had sort of targeted probably seems a bit conservative given the level of interest. So again. This is this is a level that would have been below what we're currently anticipating for 2022.
But a level that would deliver good good cash flow. So we'll be very market responsive, we will gear, our production levels and hours in our sales to the market.
But again, we have a solid foundation. We also continue to see meaningful potential for additional volumes yeah. The only thing I'd add to what <unk> said as well.
We'll be smart about whatever we do because we're not going to invest in capital that chases some incremental tub and the thermal side anymore that's over with.
Okay.
Really appreciate all the color and good.
Good work and continued best of luck.
Thanks Lucas.
And we can now take our next question from Nathan <unk> of the Benchmark company. Please go ahead.
Hey, good morning, guys congrats.
For taking my questions.
I would say you know probably most of my questions have been addressed but if I go back real quickly to the 50% discretionary cash flow bucket I know ultimately it's a board decision sounds like maybe we'll hear something late in the second quarter, but.
Do you guys have a preference between the share buybacks, obviously your stock and the rest of the market under pressure here in the last few days or you know.
Addressing the convertible as you mentioned earlier too.
Would you estimate the cost to.
To fully repurchase that convertible and maybe talk about any benefits from that actual thank you.
Yes, Nate this is Mac deal Jim I guess first thing I would say that buying back the entire convertible is not really an option at the moment. The first call date doesn't it doesn't come into play until 2023, but obviously there are things you can do in a one off manner related to that I would argue.
From our perspective, there's at this stock price and where the converts are in the money today.
Not a significant difference I don't think as we view it between the buybacks and the convertibles you do get a little benefit by addressing the convertibles, reducing the debt piece in and.
In the interest, but that's fairly marginal with where the rates are on that today. So I would say from management's perspective, theres not a significant difference between the two.
And look if the stock price continues to be under pressure there may be some benefit to going to the straight buyback method. Our approach because that does give you maybe a little more bang for your Buck.
But again theres not really a significant difference in the way we're viewing the two of them are native to the stack and if you think about where the prices right now you'd say that with a capped call feature taken into consideration, it's about 75% of any dollar would be going towards.
Avoiding future dilution and about 25% would be towards debt reduction so really heavily weighted towards the equity side of things and as Matt said very much similar to simply buying back the shares with that small incremental piece being associated with with reducing debt.
Got it makes sense. Thanks, <unk> and then maybe just kind of a modeling question, but you mentioned <unk> capex was going to be the low for the year.
Any comments on kind of cadence throughout the year, just as we look at it and you're trying to calculate discretionary cash flow with a potential 50% variable dividend could look like in the coming quarters.
Yeah, Nate I don't believe theres going to be a lot of variability over the remaining quarters I think it should be fairly fairly ratable. The rest of the way. So you know in terms of the modeling that's probably the easiest way to look at it.
Got it.
And then maybe.
Shifting to the macro.
Obviously, you guys mentioned you know what's going on in Eastern Europe between Russia, and Ukraine. Just curious how you know maybe that's affected your business do you guys ship any coal to that area and then maybe it would be great to get your thoughts on how the Covid lockdowns in China might be.
And how do you see that play out thanks.
Yeah Native stack and I'll I'll start with that and certainly you know that you were seeing disruptions associated with the hostilities in Europe without it without a doubt.
There are a lot of quite frankly, I mean, if you if you look on the coking coal side of things and really.
View that as kind of the heart of the matter and the biggest driver behind these elevated coking coal prices is just supply pressures and supply constraints and this isn't a new story. It's a story that's been under underway and ongoing for you know for many years now it's just a function of underinvestment largely but that.
It also means then theres just no resiliency in the in the in the logistics chain and the operations change. So when you do see these sorts of disruptions.
It's exactly exacerbates the situation pretty profoundly the biggest thing is that look Russia supplies about 15% of global coking coal supply and right now there's a big question Mark as to how many of those times are actually going to make it into the seaborne market. This year now you've got a whole lot of issues around that and around that <unk>.
John You've got you know the.
The challenge is just getting ships to load in Russia right now you've got the challenges around financial transactions, you've got rail infrastructure issues in congestion moving those additional tons to the east since a lot of the European tons, the 10 million tons or so that Russia ships to Europe likely aren't going to be going to.
To the west they're gonna be heading east so lots of challenges there and lots of question marks but in the end the 50 million tons or so the Russia sends in the seaborne market place is probably not going to be 50 million tonnes, it's probably going to be something less and again, that's going to just put additional supply pressures and when you add that to the fact that look Australia year to date is once again.
Down after after peaking in terms of exports at all.
Roughly 190 million tonnes in 2016 falling to 172 million tonnes of exports in 2020 168 million tonnes. In 2021. They are down again in Russia is more than 50% of supply.
In Canada look flat and really have lagged and are well below pre pandemic levels. All of that means that you know it doesn't take a lot of change.
Associated with the hostilities in Ukraine to translate into meaningful pressure. So I'll start there and see if others want to jump in.
Little more color on it you know it's hard to talk about this just out of the absolute tragedy.
What's going on.
Ukraine right now, but we historically had ship to some of the plants in eastern Ukraine. Unfortunately were.
Damaged three or four years ago in the first Russian incursion into the Ukraine.
No we haven't shipped there I don't think since 2018 or 19.
The other interesting data point I think I'd put out there is we have had interest from European utilities on term business out of the Gulf that we have not seen.
And frankly.
Frankly, I don't know that I've ever seen anybody wanting multiyear contract, but I think it's indicative of what's going on and frankly, they are looking for surety of supply and diversity of supply.
Very helpful color guys I appreciate that and then maybe Paul or have you just wanted to get your thoughts and maybe high level of space. I mean, we've talked about lack of investment in Colo last year's maybe there's a depressed pipeline of prospects out there.
Any thoughts there or even on the slide.
You know M&A further need for consolidation are you guys finding that youre hearing more discussion on this today. Thanks.
Yes, I think you know the the basic answer is the same you know I think we can all agree consolidation that lowers costs overall makes sense, but those are extraordinarily difficult deals to put together.
You know frankly will kick have retired we'll we'll look at everything but you know I.
I just don't know how some of these deals get put together with any ease.
You know I don't think theres any appetite for anybody borrowing any money and there shouldn't be.
This business I think is going to have to go forward running on a cash basis.
Look the general concept.
There's no question. The Underinvestment is starting to manifest itself and we're seeing it on the coking coal side, but I also think you are seeing it on the thermal side.
There is a lot of mines that are getting long in the tooth and the ability to respond is just not what it used to be and I think as I stated earlier.
I look at the domestic.
Thermal prices, yes, there's a there's an aspect of that in there that you know.
We just haven't seen the reinvestment, particularly out west so maybe I'm not sure that completely captured it or if anybody else has anything to add to that.
No Paul.
That's still helpful. I appreciate that as always I'll leave it there. Thank you guys for the time.
Thank you Dave.
We can now take our next question from Michael Dudas of vertical research. Please go ahead.
Good morning, gentlemen.
Hey, Michael.
Oh, so interesting the Europeans wanting term business out of the Gulf.
It's pretty crazy.
How does it and so maybe towards the coking coal side and given the tightness in the scarcity that appears to be being priced in the market.
Are you getting different customers, reaching out are you in.
Sure you're trying to help the ones you already have you know when we think about marketing your coal to the export market, which I assume is going to be continue to be a vast majority of what you do you are you book over the next several years.
Is it different regions is because of what's going on in India is that something that's more.
So relative to other areas just want to get a sense of.
Where that's driven in much whats sustainability on those customers given that I'm sure whenever you're gonna correction.
You'll see some things out in the market.
Yes, Michael Good question and I'll start here I'm sure others will follow in.
Going back in history, a little bit here.
We have with the addition of Leer South.
We're growing our opportunity from essentially seven to 10 million tons on an annual basis.
We normalized run rates et cetera. So traditionally if you look historically at where we were shipping a lot of our exports predominantly a lot of those exports.
We're going into into Europe , However, with Leer, South coming online we've been very focused on the developing opportunity that's occurring.
In Asia.
And so that's been a primary focus for us that's where we've seen most of our export growth as as we move forward and where we would expect that to continue from the perspective of of the development of customers. We've got a very unique product in the high vol. A we've worked really hard in the Asian markets.
Help those customers understand the qualities of that coal.
It's been well received and so we think we're building durability and sustainability.
Into those markets and those customers as we move forward so.
We're always going to look to optimize the portfolio of our high quality coal between the North American markets between the European markets, The Asian markets South American markets.
We've seen a significant increase in the Asian markets as we sit here today and look forward.
At least for 22 of the exports that we have ultimately.
We may see kind of a 50 50 split between the European.
South American markets, and then the Asian markets, So Michael It's OK Paul Yes.
Yes, so Michael.
As John said, we've already penetrated really most of the major markets that there are several large international steel producers have signaled that they don't plan to take Russian material, but we already have strong relationships with those who signaled that so again, we already have a pretty strong platform. There will say that we recently shipped call for the first two.
I'm in Vietnam. So we are finding those opportunities in southeast Asia, certainly India continues to be a target and we've been expanding our presence there and then we've referenced it several times before but the fact is that we did have a successful term contract in China.
That really has gone very well and we'll see if that becomes a more durable part of the order book. So again, we continue to evaluate all of these opportunities. We do believe Asia is going to be the center of growth on the integrated steel side. So we expect to be competitive there we've been building those relationships with the.
And now that the realization of Leer, South coming online so Asia will become a bigger part of the business and as you can see we are in fact expanding out those relationships.
The other thing I'd add Michael is it's more of a philosophical approach to the way we market. Our coal is look we focused on mail major steel producers globally, we have avoided the broker business.
The selling of disparate blends that works for others.
But we have preferred to set up relationships with the major steel producers globally.
Having said that when people approach us now about coal our first preference will be to take care of the customers that have been loyal to us and we will continue to do that and if we can will help others, but first and foremost.
Our business model says stick with the people that you've been working with.
That makes a lot of sense I appreciate that.
And just a quick follow up turning to your on the thermal side.
Despite the near term gas in.
Sure sure.
Higher prices and inventories below our.
Thermal customers with utilities changing the way they're thinking about.
Florida over the next several years are they still are you read about.
Utilities accelerating coal plant closures, but.
Is there any.
Slowing that down in some cases or in a sense maybe utilizing.
Taking that 50% utilization.
Two.
Generate electricity required given where gas.
The ability of the new mill.
Michael I'll start I'm sure others will have thoughts as well but.
From a long term perspective, the ultimate outcome here is likely the same where we're going to see continued closures domestically of coal fire generation I.
I think with what's happened here in the last year and you have seen publicly some discussion and announcements of delaying closures postponing closures, we've seen that anecdotally play itself out over over.
Our discussions with the utilities however.
And we indicated this we knew there might be pockets of opportunity here and that we wanted to be in a position to be responsive to that so those opportunities have presented themselves.
We've.
Gotten into books of business here and an extended.
Our portfolio of sales into future years at attractive prices. So we will take advantage of that but at the end of the day, what's important for US is to operate responsibly. That's why it's important that we're setting aside money into the reclamation fund.
Into feazing any obligation that we have well into the future, but in the meantime, we will take advantage of what this market is offering.
Michael.
We started we started 2011, we started the last decade with about 315 gigawatts of installed capacity power generation capacity coal based power generation capacity in the U S.
At the end of this year, we're still going to have about 200, gigawatts still installed and a lot of the closures that occurred early on were older plants. Now clearly we are going to continue to see this window down and yes, theyre going to continue to be closures and we expect that to roll on to the next five years, but there is still meaningful installed.
City, the lack of investment even in the remaining fleet is starting to take a toll as well. So the capacity factors that can be achieved probably arent what they once were but as indicated we do believe the fleet can run at higher levels. We do believe we are positioned to take advantage, but as John said I think the end result, we do believe that.
That you know youre going to see the end result is going to be the same I would say in terms of how utilities are buying it does feel like it's changed to us over the last year or so and some of this with the higher gas prices.
I think we've gotten to the point, where you know utilities, we're probably buying 35% or so or even more of their volumes they needed for a given year intra year within that year suddenly we're seeing much more interest in longer term contracts and we've even signed some sort of five year deals here.
And so we are getting some length and I think that is a function of uncertainty around natural gas concerns about not having availability of the underinvestment in thermal supply as well that Paul referenced. So we are seeing a change there and seeing what appears to be some rethinking of how utilities go to market.
Encourage thanks gentlemen.
Thank you Michael.
And we can now take our final question from David Gagliano of BMO capital markets. Please go ahead.
Alright, great. Thanks for taking my follow up it's actually related to what you were just talking about actually.
It sounds like the utilities rethinking strategy potentially over time, what about arch you know the strategy I thought.
Not too long ago was basically wind down in the thermal business cut the footprint by almost 50% over three years now I realize that's been pushed out.
But what is the strategy now for the thermal business within arch.
David it's unchanged.
You know you stand back and look the the current events have maybe changed the glide path of the decline.
We all I think know where this and.
What we're tasked with I think is figuring out how to take what's going on.
The global thermal markets and figuring out how to play them best here at home.
I think we will continue to generate cash out of these assets, but we're simply not going to put any more cash into them. We will do what we have to.
The feed them and keep them going but any thought of increasing production.
And what we have the ability to do with the equipment on hand is completely out the door I just I can't see it it's not what our shareholders want and I don't think it's a good investment for us.
Frankly, there is just better options out there.
And.
But at the same time.
With the setup of the thermal reclamation fund you think about it we can run this as long as it's profitable and as long as it makes sense, but the second it stops I have no hesitation in doing we have to do ultimately which is close these operations.
Okay. That's helpful. And then you mentioned something there you know not increasing production beyond what the equipment is capable of doing and obviously volumes were up 17 or roughly 70%. This year. The target is up 17% year over year 2023, what's the equipment capable of doing or are we looking at more incremental.
Volume growth in 2023, and if so how much.
David we're reaching Max capacity of what the operations capable capable of with the fleet of equipment that we have and so there is not an ability.
Increased production from where we're at at today's levels. We do think in 2023, it's potentially replicable to do what we're doing this year in 2023, but again the constraint will be you know we're going to do it only with the same kind of subsistence level sort of capital spending that we've been we've been doing we're certainly not going as al said we're.
Not going to chase the market, but we are going to try to wring out all of the value. We can and really harvest strategy was always about that which was about expanding just maintenance capital only and taking the cash that we could that we could recover recovering as much of the remaining value as possible and quite frankly, when you look at the reserve base they'll come in.
When we you know we've mined out the reserves as well, we still have more than 500 million tons, but you know that we.
We don't plan to invest further so I think thats that.
That continues as Paul said, there there's real clarity here in terms of where we're going with this thermal strategy.
But ultimately we are going to continue to try to take advantage and be opportunistic with changes in the marketplace that occur between you know the lip in the car.
Last thing I'd say and its the comments I made I think a year ago.
Look as we narrow the liabilities down by doing reclamation and building the sinking fund, but there is an opportunity or an increasing opportunity to sell these assets I don't you know I think I was hesitant to say it was a very strong chance of.
A year ago, but look that that opportunity still exists we've had a lot of interest but frankly.
Drawing the line first we got to get the full value that we think are left in the assets and second it has to be a clean sale.
We're not going to do something that could harnessed 510 years down the road.
Alright, that's very helpful. I appreciate the additional color. Thanks.
Thanks, Dave.
We have no. Further question. This now concludes our Q&A session I would like to hand, the call back to Paul Lang for closing remarks.
I'd like to thank you again for your interest in arch today's announcement of the first substantial dividend under our new capital return model represents a milestone in the evolution of arches value proposition and reflects the board vision for creating value for our shareholders. While commodity markets are inherently volatile we believe the <unk>.
On the metals for coking coal are well supported which should set the stage for further meaningful capital returns as the year progresses.
As I noted earlier, our <unk> story is by design and increasingly simple one.
We've completed the hard work and taken the necessary steps to build a world class coking coal portfolio with a very compelling cash generating potential having.
Having done so we believe we are well positioned to capitalize on the current market in a way that benefits our shareholders.
With that operator, we'll conclude the call and we look forward to reporting to the group of July staying safe and healthy everyone.
Yeah.
This concludes today's call. Thank you for your participation you may now disconnect.
Yeah.
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