Consol Energy (NYSE:CEIX) is a very low-cost, eastern U.S., thermal & (coking/metallurgical) coal company with a high and growing proportion of sales [44% in 2022] into Europe & Asia.

The Company has 622M tons of proven & probable “recoverable coal reserves,” at its three largest mines in Pennsylvania, ~25 years of mine life at last year’s production level.

Nameplate capacity on Consol’s three primary mines is 28.5M tons/yr., plus a new premium quality, low-vol coking coal operation ramping up in West Virginia (WV) with capacity of ~1.5M tons/yr. While not large, it would deliver triple-digit margins at current coking coal prices and has a 15+ yr. mine life.

Consol’s reserves have an average heat content of 12,972 Btu/lb., ~15-20% above the average of primary coal seams in other key regions that range from ~8,400 to ~13,000 Btu. {coal quality comps}

Seaborne thermal coals from S. Africa are 10,972 Btu, Indonesia (the world’s largest exporter); 9,092 Btu, Colombia; 12,900 Btu & Australia; 10,130 to 13,000 Btu. High-Btu thermal coals cross over into the coking coal market when demand is strong.

Some will never invest in fossil fuels. The fact that coal companies are blacklisted by a subset of investors is likely a big reason why Consol is trading at a substantial discount to other mining & energy companies.

And, the mining & energy sectors are trading at significant discounts. Consumer staples, consumer discretionary, info. technology, healthcare, communications & utilities trade at an average (forward) Enterprise Value/EBITDA ratio of 11.2x. (source: Seeking Alpha, “SA”).

By contrast, CEIX is trading at 1.7x estimated 2023 EBITDA, vs. the energy sector at 5.5x. Some coal companies are in the materials sector, trading at 7.6x. As risky as coal is perceived to be, one could argue that a lot of downside is priced in.

Still, this valuation disconnect begs some questions…

Is CEIX a tiny company that shouldn’t be compared to larger firms?

No, its enterprise value {market cap + debt – cash} is ~$2.7 billion, while the median market cap in the Russell 2000 is ~$1 billion.

Does Consol have a debt-laden balance sheet?

No. [Net debt + legacy liabilities] divided by Adj. EBITDA is down 81% from 5.3x in 2017 to 1.1x at 12/31/22. By year end the ratio should be under 0.5x. And, there are just 34.75M shares outstanding.

Does Consol have above-average earnings risk?

No, ~92% of 2023’s sales are booked at attractive (fixed) prices. This year’s operating margin is expected to be 30% higher as management is guiding to roughly a $46.00/t margin vs. $35.33/t in 2022. And, the midpoint of production guidance calls for a gain in sales of 1.9M tons to 26M.

Is Consol’s robust dividend at risk of being cut?

No. The words, “shareholder return” — referring to an increase in BOTH dividends & share repurchases — were uttered 12 times on the Feb. 7th earnings call.

Management announced it will distribute 35%-50% of quarterly cash flow this year via dividends + share repurchases. At $53.37/shr., CEIX is yielding 8.24%. If cash flow increases in line with announced sales & margin guidance, the annual dividend could increase from $4.40 to ~$6.18/shr. {assuming a steady payout ratio of ~40% for dividends + share buybacks}.

What if coal consumption in the U.S. craters?

For argument’s sake, assume that coal consumption in the U.S. falls dramatically. This chart from the EIA shows it has declined at an average annual rate of 3.9% since 2006, {in 2022 coal consumption increased to 592M tons}.

What if U.S consumption were to slide by 10%/yr. through 2030? Does that mean Consol’s sales would fall from an expected 26M tons in 2023 to 12.4M/yr.?

No, as domestic consumption declines, exports will likely increase. Consol is one of the best positioned producers in terms of exports. It owns 100% of a coal terminal in Maryland with 15M tons/yr. of capacity.

That terminal is the only east coast port connected to BOTH Norfolk Southern (NSC) & CSX Corp. (CSX) rail lines. No other major coal producer owns a sizable coal export terminal. In 2022, the Company exported 10.7M (44%) of 24.1M tons sold.

On the earnings call it was stated that the Company could export up to 14.0M tons next year, more than half of expected sales.

In its Feb. 10th 10-K filing is the following commentary about the Company’s exports through its owned terminal,

Importantly, the Company reported that it was in the lowest quartile of global operating costs as of 2021. Therefore, all else equal, higher-cost mines would be curtailed and/or retired before Consol’s operations. That $5-$8 per export ton represents a significant, long-term sustainable advantage.

Domestic consumption that remains in demand longest will have a combination of 1) low-cost, 2) high-quality, and 3) logistical flexibility. For instance, Consol has some high-Btu, low-impurity thermal coal that periodically crosses over to the coking coal market, generating very strong margins.

Therefore, for a number of reasons, if U.S. consumption were to fall 10%/yr. through 2030, (which I don’t expect), Consol’s production would, in my opinion, decline far less. On the back of strong exports, plus high-Btu / low-cost attributes, and its new WV operations — I see Consol continuing to produce 20M+ tons for many years to come.

However, if I’m wrong and EBITDA were to fall in half by 2030 from the 2023 consensus estimate of ~$1.1B (marketscreener.com), due to lower production AND lower prices, EBITDA would still be ~$550M. At that level, with shrinking annual cap-ex, interest expense, legacy liability costs (& fewer shares outstanding), cash flow per share available for dividends & buybacks should remain fairly strong.

Does the recent collapse in nat gas prices signal the end of thermal coal?

Readers who follow the energy/mining sectors have noticed that nat gas prices are down very substantially in the past three months. Nat gas has fallen to $2.10/MBtu from nearly $10/MBtu, but is up ~22% to $2.57/MBtu in the past several days.

Since many power plants can switch between coal and nat gas depending largely on relative prices, this is a serious concern.

Clearly very low nat gas prices (if sustained several more quarters) would be bad for coal. However, utilities have learned the hard way that coal & gas prices are highly volatile, making it critically important to keep all options open.

Recent weakness in nat gas is due largely to a very warm winter in Europe & much of the U.S. and sluggish economic growth (globally).

The weather will normalize and economic growth will recover, timing unknown. Energy experts point out that large LNG export facilities are coming online next year to soak up a meaningful amount of U.S. gas production.

Compared to the front month (March) level of $2.50/MBtu, NYMEX futures are at $4.15 / $4.50 / $4.68 & $4.81/MBtu for Jan. 2024 / 2025 / 2026 / 2027. While weakness in prices could last into Spring, it seems possible the worst news is out.

Of course there are risks to the Consol Energy thesis. Although ~92% of 2023 sales are contracted, utility customers could try to push back deliveries if unusual weather persists or the economy takes an unexpected turn.

In the past when coal demand was weak, producers would be at serious risk due to much higher debt levels / interest expense and an inability to resell contracted tons not taken up by customers.

However, as scary as the natural gas chart is, take a look at the API2 thermal coal price index that management often cites. It shows a very substantial decline from above $400/t, but notice that the current level of $139/t is above any price in the 10 years to June 2021, and well above any price to Jan. 2021.

Coal prices remain fairly robust, great news for low-cost producers like Consol. Unlike in prior downturns, with the export market still relatively strong, management believes it could benefit if domestic users wanted to defer contracted volumes.

What if U.S. coal demand does not crater?

Starting next year the board will have ample room to increase the portion of cash flow allocated to shareholder-friendly uses.

Earlier I discussed a 10%/yr. downdraft through 2030 in domestic coal use. The chart below shows an entirely different view of U.S. production, but for U.S. exports into the global seaborne market from 2022-2030.

While demand falls by 119M tons/yr. in the, “Rest of World,” countries like India, Vietnam & the Philippines offset 83M tons of that deficit.

This data shows a 4% cumulative decline in annual seaborne thermal coal demand (globally) in 2030. That’s why Consol’s team is so focused on exports through its coal terminal. Many countries have steel & power plants near their main ocean ports, making seaborne markets for both thermal & coking coals more robust.

Another supportive narrative for resilience in top-quality, low-cost, highly efficient producers is the fact that coal companies are no longer looking to meaningfully expand production. With limited new supply in the pipeline, there will likely be periods when coal prices soar again as they did in 2021-22.

Evidence that growth cap-ex is in decline can be seen in the very high dividend payouts & share buyback activity by companies including Consol, Arch Resources (ARCH) Alliance Resource Partners Partners (ARLP), Yancoal Australia Ltd. (OTCPK:YACAF), Whitehaven Coal (OTCPK:WHITF) & New Hope (OTCPK:NHPEF).

Any discussion of fossil fuels requires the topic of Russia to be addressed. One could write an entire article on the impact on fossil fuel supply/prices around the world due to Russia’s invasion of Ukraine. Suffice it to say that coal exports from Russia are in serious trouble.

Although Putin has been able to find buyers (reportedly at significant discounts) its energy products, in my view new investment to keep the coal flowing will be hard to come by, especially as prices fall. Russia was the world’s 3rd largest coal exporter in 2021.

Consol could have more cash than it knows what to do with, even after distributing 35%-50% of earnings. This gives management the opportunity to make acquisitions outside the coal space.

Other companies are diversifying income streams, even if it means acquiring oil & gas assets like Alliance Resource Partners. On a greener note, Peabody Energy (BTU) formed a JV last year to pursue the development of solar power & battery storage projects. Generating new income streams could, (if successful), would mitigate declines in U.S. coal consumption.

Conclusion

Investors in Consol Energy (CEIX) pocket an 8.24% yield for a company trading at a forward EV/EBITDA ratio of 1.7x. Never have U.S. coal companies had such robust cash flow & strong balance sheets after such a rapid & dramatic fall in coal prices.

That’s because astute management teams locked in very high prices… did I mention that ~92% of this Consol’s sales are contracted at high fixed prices!?!

Consol has a lowest quartile operating and strong export capacity. It can withstand a (potentially) significant decline in domestic coal use by increasing exports through its 15M ton/yr. coal terminal and watching higher cost mines around them shut down.

Its world-class mines are superior in other key respects besides just cost — incl. quality, efficiency & remaining mine lives — making them likely to be among the last ones standing in the 2030s/2040s.

Management is ramping up a new low-vol coking coal mine in WV that should be a cash cow with monster margins for the next 15+ years.

Given new company guidance on production, pricing & costs, dividend hikes from $4.40 up to ~$6.18/shr. (a year from now) seems a reasonable outcome.

Even if Consol’s share price were to soar 50%, its pro forma yield on a prospective $6.18 dividend would be an attractive 7.7% and its EV/EBITDA multiple would be 2.6x, hardly a stretched valuation.

Reading the latest earnings call transcript and presentation slides is a great way to learn more. As a reminder, the Company’s annual 10-K filing came out on Feb. 10th.

View article here.