SunCoke Energy, Inc. (SXC) Q1 2013 Earnings Report, Transcript and Summary

Welcome to the First Quarter 2013 Earnings Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Mr. Ryan Osterholm. Mr. Osterholm, you may begin.

Thank you. Good morning, everyone. Thank you for joining us on the SunCoke Energy and SunCoke Energy Partners First Quarter 2013 Earnings Conference Call. With me are Fritz Henderson, our Chairman and Chief Executive Officer, and Mark Newman, our Senior Vice President and Chief Financial Officer. Following the remarks made by management, the call will be opened for Q&A. This conference call is being webcast live on the Investor Relations section of our website at www.suncoke.com. There will be a replay available on our website. If we don't get to your question during the call, please call our Investor Relations Department at (630) 824-1907. Now before I turn over the call to Fritz, let me remind you that the various remarks we make about future expectations constitute forward-looking statements, and the cautionary language regarding forward-looking statements in our SEC filings apply to the remarks on our call today. These documents are available on our website as are reconciliations of any non-GAAP measures discussed on this call. Now I'll turn it over to Fritz.

Thanks, Ryan. Good morning. Our first quarter 2013, we accomplished a couple of pretty significant strategic milestones. First, executing the MLP IPO of SunCoke Energy Partners. We did recently declare the first quarterly distribution prorated for the 67 days in which the business was public. We also, given the strong performance of SunCoke Energy Partners and specifically the Middletown and Haverhill coke batteries, we do expect and we announced that we would increase -- we would expect to increase our quarterly distributions by about 2.5% for the next quarter, and anticipate an overall increase of approximately 7% for the Q4 2013 distribution, which would be paid in early 2014. We also completed the -- and closed our joint venture with VISA Steel, called VISA SunCoke, marking our entry into India. Invested our $67.7 million for the 49% stake in that business. Our coke performance in our core business was improved, and that was off of a good period last year. So we felt good and we'll take you through more detail about that. That's driven by our Middletown facility. As we'll talk about later, the one plant where we've had the struggles has been in our Indiana Harbor plant, but the rest of our operations have performed steadily relative to, I think, a good period last year, and Middletown continues to post excellent results. Our coal business, we did see in the quarter progress on productivity and reduced cash cost; we'll take you through that. What we also saw is a significant reduction in price, which is what we expected coming into the year. And finally, we ended the quarter with substantial flexibility, about $200 million of cash attributable to SXC at the quarter even after the India investment and $106 million at SXCP. So turning your attention to Page…

Thanks, Fritz. As Fritz said, this was a good quarter in line with our expectations. We started with revenue being down. As all of you know, coal is a pass-through in our coke business model. So with lower coal prices, it affects our revenue. And so in part, it was due to coal prices, both in our coke business and our coal business, and in part due to lower volumes in terms of coke sales, primarily driven by production at Indiana Harbor. On the EBITDA front, our coke business continued to improve. We saw an $8.8 million improvement year-over-year, largely driven by Middletown, and I'll take you through that in the EBITDA bridge later on. And then coal was negative in the quarter, again driven by a $50 per ton year-over-year price decline, which was partially offset by about a $23 cash cost per ton reduction, and I'll take you through that in more detail. On the EPS front, again, a number of items that we expected. The accelerated depreciation at Indiana Harbor, our forecast for the full year when we took you through our full year guidance last quarter was $0.14. So this quarter is relatively heavy. Again, the refurbishment is well under way, with our full year expectation still remains at $0.14. We did have the debt issuance related to the MLP. Again, we had expected this to be $0.05 to $0.06, so this came in line. And then finally, the income attributable to SXCP is approximately $0.07 in the quarter and are against our expectation for about $0.30 for the full year. The one item that we did not expect relates to a number of tax items. I'll take you through that when we go through the EPS bridge, but that was about $0.05 in the quarter.…

Thanks, Mark. Just wrapping it up, Chart 18 outlines our priorities for 2013. 3 pillars that we continue to work from and that we've shared -- we've shared this with a number of investors over time. Starts on the left side with operational excellence, sustaining our momentum at our coke facilities, executing the Indiana Harbor plan, and that really involves refurbishing the plant while we run it; it involves addressing the environmental noncompliance that we've had in prior periods, the NOV; and a significant amount of what we're doing to refurbish the plant, not exclusively, but we'll certainly significantly improve our environmental performance as well. And we have seen improved environmental performance this year at Indiana Harbor. And then finally, renewing the contract with ArcelorMittal and concurrently doing so with Coke Energy, which is the -- our partner in the back end of the plant. So Indiana Harbor is a multifaceted project, but as I think about our Pareto chart of things to do on the operating side of the business, this remains the critical operating priority for us, both refurbishing and executing the project, improving production, improving cost, improving environmental performance and renewing the contract. Discussions continue with ArcelorMittal by the way in that regard. Implementing the environmental project at Haverhill and Granite City, with Haverhill being the lead project, the lead for that site, so -- excuse me, for that project, so -- and Haverhill has begun, as you saw in the CapEx for SXCP. Continuing to execute the coal mining action plan to decrease cash costs, we were encouraged by what we saw. Mark mentioned the productivity factors, and I think we see that we can continue to make progress in that area and then finally, maintaining top quartile safety performance. In terms of growing the business,…

[Operator Instructions] Our first question comes from Dave Katz from JPMorgan Chase. Bayina Bashtaeva - JP Morgan Chase & Co, Research Division: This is Bayina Bashtaeva for Dave Katz. So we appreciate your color on liquidity that you provided earlier, but we were just hoping to drill a little bit more into that. Could you please provide the revolver balance at the end of the quarter for both entities?

So the revolver balances, we have $150 million at SXC, $100 million at SXCP and they're both, I think, almost completely undrawn.

Right. We have on the -- so the SXCP, $100 million revolver is completely undrawn. We have a $0.9 million LC against the $150 million revolver, so it's effectively undrawn. Bayina Bashtaeva - JP Morgan Chase & Co, Research Division: And if you just can give me like what are the debt instruments at the end of the quarter at SunCoke Energy, the debt balance. Just trying to make sure...

So at the end of the quarter, as a result of the $225 million paydown of term loan at SunCoke, we have approximately $100 million of that term loan. I think it's about $99 million outstanding. And then we have $400 million of senior notes. At the MLP, we have $150 million of senior notes, which we issued as part of the IPO transaction. Bayina Bashtaeva - JP Morgan Chase & Co, Research Division: And my second question is regarding your proposed investment in the ferrous side of steel value chain. Where would you think about investing geographically? And what choices are made when evaluating any partner investment?

So geographically, if we're talking about MLP investments, we'd be looking at North America and in particular, in the U.S. There are MLP assets today in publicly traded MLPs that are in Canada. So I'd say the U.S. and Canada would be our geographic focus relative to MLP growth. Outside of MLP growth, our single focus remains in growing our India presence and building on our franchise of VISA SunCoke.

Our next question comes from Brett Levy from Jefferies. Brett M. Levy - Jefferies & Company, Inc. Fixed Income Research: You've got a good venture going in India, and yet China is still the big monster with 700 million plus of capacity, most of it integrated. What are the challenges and have you located any opportunities on the China side of the ledger?

Brett, good morning. I would say we have not identified any opportunities on the China side. There is no shortage. We've done a fair amount of work on research. We've been over to China, we've talked to partners, we've talked to steelmakers. Interestingly, there's about 400 million tons of coke production or coke -- actually, there's coke production at about 400 million tons. I think there's coke capacity well in excess of that. And interestingly, about 30 million tons of that is heat recovery in one way, shape or form. I would say the market is oversupplied in a pretty significant way, and we have not identified the opportunity which we think would put us in a position of being needed and wanted. In other words, I really think that the strategy in China is you need to bring something that's unique and different and makes you an interesting opportunity for a partner and/or for a customer, and we haven't identified that. So our focus today, therefore, is on India. We remain -- we continue to watch what's happening in China because it is the single largest -- 60% of global coke production takes place in China. But as we look at the opportunity to grow, our focus is not only on growing our production, it's growing our profitability. And I really haven't identified an opportunity in China that we think would result in a good investment. So at this point, it's maintenance, and we're going to focus on making India successful. Brett M. Levy - Jefferies & Company, Inc. Fixed Income Research: Okay. And the second one is a bit more of a bondholder question, vis-à-vis where your leverage is now and sort of as you look at your initiatives going forward, are you kind of where you want to be from a leverage standpoint? Or do you seek to delever at any point? Or is there anything sort of even more levering that you'd consider?

So Brett, it's Mark. What I would say is -- let's start with the MLP first. The MLP today is levered at about 1.7x, and we would say 3x to 3.5x is probably a good ongoing leverage ratio for that entity. So the MLP is intentionally underlevered to basically allow it to grow through acquisitions. At the C Corp up at SXC, we achieved actually a very significant deleveraging with the IPO transaction. And so today, I think we're approximately 3x levered up at the parent, which I would say is somewhat conservative but feels comfortable to us. So I'd say, we think the parent is appropriately levered, maybe a little underlevered, the MLP is underlevered intentionally so that we can grow it.

Our next question comes from Andre Benjamin from Goldman Sachs.

First is a multi-part question. I was wondering if you could help us think about how to handicap how much of the kind of 4 million tons of MLP assets you identified that you think will actually end up being suitable once all is said and done? How should we think about the likelihood of getting deals done for the coke assets versus some of the other stuff like coal and iron ore, which you identified as likely to have a shorter cycle in terms of getting deals done? And I guess the last thing is how do you think about the risks of operating some of those assets since they're not really part of your core business?

Okay. One step at a time. Let's talk about the 4 million tons of batteries that we think could potentially be acquired and I'll also talk about the 4 million tons of batteries that we think could potentially be retired. Let me start with the 4 million tons of batteries that could potentially be retired. The plant we're working on -- excuse me, the project we're permitting in Kentucky, our preferred location, would be 660,000 tons. So if these batteries -- we see it pretty regularly, the old, the very old coke batteries continue to wear down and wear out. So again, this is why we're pursuing permitting another plant. It wouldn't generate EBITDA until 2016. However, this is our core business, building and executing heat recovery projects, and so we continue to work on that. On the acquisition side, I would say, again, there are 5 people to speak with, so -- and we know all 5, so the dialogue has begun. I would say, the complexity of assets, not only their environmental footprint, but their degree of integration, raises, I'll call it, deal complication, not insurmountable. And I think we've shown a willingness and an ability to deal with complicated structuring issues. So I think that the issues regarding the assets themselves can be addressed. I would say the issues of customer interest is varied. I mean, some customers are really not particularly interested, some are quite interested, so -- and some are, well, show me what the numbers are. So that's the reason why we're talking to all of them. And so I would say, as a practical matter, as I look at it, the ability to execute a deal in 2013, for example, could be done, but not likely just because these are going to take…

Very, very helpful and complete answer. I guess the shorter follow-up would be maybe an update on where you stand in VISA SunCoke just in terms of management and board appointments and coming up with a strategy and kind of when you hope to maybe update us on all that?

So Andre, the VISA SunCoke board will be 3 members from each of the 2 shareholders. So while we hold a 49% stake, the company will essentially have a deadlock board. In addition, our VISA Steel partner will appoint the Managing Director, or the CEO as we call it in the U.S. We will appoint the CFO, so the CFO will be a SunCoke employee and seconded to the venture. And both the CEO and the CFO will sit on the board of VISA SunCoke. In addition, at -- from our side, Mike Thompson, our COO, and Nelson Garcez, our head of our Venture Development, will sit on the board. And then from the VISA Steel side, I think both sons of the founder will be on the board as well. So the board will be well represented and we will appoint a key senior leadership in the venture. We're still working on our CFO appointment. We're getting very close. At the current, we have an interim person who is part of the SunCoke team on the ground in India.

Just to fill that out, Mark's right. We actually are also going to be augmenting the operating resources at the venture, not on the board level. But the intention is to bring aboard some operating talent to second them to the venture as well. And the objective here is to build a bridge, if you will, from technology from SunCoke into our venture in India, but do so with Indian nationals. So there will be a fair amount of support here from Lisle, but nonetheless, we think having assets on the ground, people on the ground is going to be helpful. So I would say, well, the CEO is named. Mark is correct, we've very close to naming the permanent CFO and the board is basically constituted. The only thing I'd add is that, we have a 50-50 board, our objective is to not deadlock it. But it can be deadlocked if it needs to be, so -- but it's -- no, it's a true 50-50 venture, notwithstanding our 49% interest.

[Operator Instructions] Our next question comes from Sam Dubinsky from Wells Fargo.

Just a couple of quick ones. Can you walk me through the $93 EBITDA per ton for SXCP again? What in there was one-time, what should we model for Q2 based on maintenance outages? And I have a couple of follow-ups.

Well, nothing in the 90 -- I wouldn't -- Sam, it's Mark. Nothing in the $93 per ton is "one-time." We did have a very strong quarter. And obviously, on a year-over-year basis, Middletown is benefiting from not having start-up costs and having better cost recovery in the quarter. The outages that I referred to are in Q2, and the -- let me just check my notes here -- I think are both at -- actually, at Haverhill and Middletown, related to HRSG work, work on our heat recovery steam generators. So I guess what I was flagging is really 2 things: One, at the SXC level, I would expect our EBITDA per ton to be down, again, within the range, but maybe at the lower end of the range in Q2. With respect to SXCP, what you shouldn't do based on our full year guidance is annualize Q1 based on relatively strong start on a year-over-year basis.

Okay. And then on maintenance CapEx for the MLP, it looked pretty low in Q1. I assume that upticks in Q2 and then trends down with the maintenance?

Yes. Usually, outages draw in maintenance CapEx, and so I would expect both our EBITDA and distributable cash in Q2 to be lower than Q1, albeit on a full year basis, we do feel like the range of coverage is between 1.16 and 1.25 at the current MQD.

Okay. And then one last housekeeping question on that. I think your interest expense at the MLP level looked a little bit high, the financing. What is that going forward? I think it was in the $6 million range. What is that going forward?

Yes, there's -- I think there's roughly $800,000 in Q1 related to the debt issuance.

About $3 million.

Yes, it's about $3 million. It's basically the -- we'll get it for you offline. I don't have the...

Offline, okay, and -- but it does go down? Okay. And then my last question is just conceptual. If you look at import pricing for coke, it has declined pretty significantly. Do you think this causes the acceleration of retired aged coke -- of coke plants that are set for retirement? Do you think some of your steel customers may shut down -- or any steel company may shut down some of their aged plants because imported coke is cheap or do steel companies tend to look much, much longer term than that?

They tend to look longer term. They don't like the import seaborne coke in part from a quality perspective. It's highly uncertain with long logistics pipelines. And if there's anything wrong with a coke shipment, you have no ability to react. So they generally don't like to do that. Our customers have actually all pursued strategies to be self-sufficient, including us. So I would say, though, that what you have seen is, in a place like India, we've seen the Chinese coke that has come into that market. We've also seen, in Europe, Ukrainian coke be accepted. The Italian blast furnace, for example, that just recently was shutting down its byproduct elements [ph], I think you'll see some more imported coke into Europe. Our view is the logical place for that to come in is from the Ukraine. Interestingly, today, what you've seen is a significant downdraft in Chinese prices, and I look at that and I think of it as a timing issue. China still imports a reasonable amount of hard coking coal and they're long coke. So they're trying to get rid of it. Once you get rid of it, the question is do you reorder it to take more losses. And I think that's part of the reason why our customers think longer term. You can have short-term fluctuations in the price of coke, but over time, the production costs will and the coal costs will be the key driver. And not certain -- if I think about U.S. customer, they're going to prefer coke sourced here with coal sourced here.

Our next question comes from Lucas Pipes from Brean Capital.

This is Derek Hernandez for Lucas Pipes. I guess my first question would be on your coal mining reject rate, if there is any anticipation of an improvement on that metric going forward.

I would say it was 66% in the first quarter. It was improved from the first quarter of last year. It was in line with where it has been running. We have made some investments in our prep plant to improve, put in a new cyclone, a new circuit. We have very fine coals, and it's helped us. I would say, though, that the principal driver of the lower cash costs has been more to do with productivity in the mines, and manpower and equipment productivity than it has been lower reject rates. So if we do see improvement and I do think we can, you're not going to go from 66% to 60% or 58%. It will be measured in basis points, if you will, rather than in full percentage points.

I see, very good. And then I was just wondering if you had any further commentary on your Indiana Harbor contract negotiations?

No, not really, nothing to add from what I mentioned in my presentation. The dialogue continues with ArcelorMittal and Coke Energy. The contract reaches expiry at the end of September. I can say that ArcelorMittal, I mean, it's a very productive constructive dialogue. I mean, I think the challenges we face at that plant operationally have been considerable and frankly have been more than we thought. And we thought we were going to have challenges coming in to trying to refurbish the plant and run it at the same time. We don't have any experience doing that. And so it's been a pretty significant challenge for us. We'll get our arms around it, we'll get it behind us. And then in the meantime, kind of alongside that, you have the dialogue with ArcelorMittal and Coke Energy. That continues. I'm quite confident we'll reach an acceptable, reasonable outcome with them. Their blast furnace continues to be strategic to them. There are no other alternatives as a practical matter. And as a practical matter, this is the highest and best use for us to supply the blast furnace there. So one of these where we need them, they need us, and I think we'll come to a reasonable outcome.

We have no further questions at this time.

Yes. Well, thank you, operator. I think it wraps it up. Appreciate everybody's interest and participation today in the call. And look forward to talking to you on a regular basis and the reporting next quarter. Thanks very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.