SunCoke Energy: Don't Get Too Excited By The Higher Guidance

Summary

• After seeing a strong first half of 2021, SunCoke Energy has materially increased their earnings guidance.
• Whilst this sounds positive, they have not materially increased their free cash flow guidance.
• This stems from higher capital expenditure due to inflationary pressure and thus mitigates the appeal or benefit of their higher accrual-based earnings guidance.
• This also poses future concerns of further inflation eroding their cash flow generation to a more significant extent.
• Whilst this is not ideal, I still believe that my bullish rating is appropriate due to their forecast double-digit free cash flow yield.

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Introduction

When reporting season rolls around every quarter, it can be quite nerve-racking for investors as they wait to see how their companies have performed with any disappointments often sending share prices plunging. Thankfully for the shareholders of SunCoke Energy (NYSE:SXC), their share price jumped higher after they raised their earnings guidance by a sizeable amount. Whilst this sounds positive, it would be prudent not to get too excited since it also contains mitigating factors, which are discussed within this article that also provide a follow-up analysis to my previous article.

Executive Summary & Ratings

Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.

Image Source: Author.

*The coke that their business centers around face a long-term threat from the more environmentally friendly electric arc furnaces.

Detailed Analysis

Image Source: Author.

Instead of simply assessing dividend coverage through earnings per share, I prefer to utilize free cash flow since it provides the toughest criteria and best captures the true impact on their financial position. The extent that these two results differ will depend upon the company in question and often comes down to the spread between their depreciation and amortization to capital expenditure.

When looking at their cash flow performance it shows that their operating cash flow increased to $105m during the first half of 2021, which stands at a massive 114.29% year-on-year increase versus their result of only $49m during the first half of 2020. Although a significant portion of this relates solely due to working capital movements, even if these are removed from both sets of results, their underlying operating cash flow would still have increased by a strong 21.51% year-on-year to $113m versus their previous equivalent result of $93m. This strong performance has unsurprisingly carried through to their accrual-based earnings and thus seen management increase their earnings guidance for 2021, as the table included below displays.

Image Source: SunCoke Energy Second Quarter Of 2021 Results Presentation.

It can be seen that they have increased their consolidated adjusted EBITDA guidance to $260m at the midpoint, which is a sizeable 16.85% higher than their previous guidance of $222.5m at the midpoint. Whilst this sounds very positive, it would be prudent not to get too excited because interestingly, their free cash flow guidance has essentially remained the same with the lower end only increasing by $5m with the upper end staying flat at $100m. This appears to stem from their capital expenditure guidance being increased to $90m from its previous estimation of $80m, which is where the problem lays because it does not stem from higher growth spending but rather inflationary pressure, as per the commentary from management included below.

“Our capital expenditures are now estimated to be approximately $90 million, as compared to the original guidance of $80 million with inflationary pressures being the main driver for the increase.”

- SunCoke Energy Q2 2021 Conference Call.

It would not have been concerning if their capital expenditure guidance increased because they were ramping up growth investments nor if these inflationary pressures were only small at $1m to $2m but at upwards of $10m, they represent an increase of circa 10% across the full year. Since they already saw $20m of their original $80m capital expenditure guidance attributable during the first quarter of 2021 before this was an issue, it actually means that the $10m increase relates to the remaining $60m and thus it represents a higher increase at upwards of 16.67%.

This is quite a large increase to see that is primarily driven by inflationary pressure, which casts concerns when looking ahead since this could begin spilling over into their operating costs and thus further impede their free cash flow. Whilst other investors are entitled to have differing views, it firmly remains mine that the intrinsic value of investment centers on free cash flow. This means that these inflationary pressures ultimately mitigate the otherwise positive outlook from their higher earnings guidance even if there is no further spillover impacting their future cash generation. At least their new free cash flow guidance of $92.5m at the midpoint keeps their shares attractive with a very high free cash flow yield of 16% based on their current market capitalization of $578m.

Image Source: Author.

Overall their capital structure remained essentially unchanged throughout the second quarter of 2021 with only small immaterial circa 1% changes in either direction across all measurements. This means that it would be rather redundant to reassess their leverage and liquidity in detail since these have no material changes. The two relevant graphs have still been included below to provide context and reference for new readers, please refer to my previously linked article if interested in a more detailed discussion regarding these two topics but suffice to say that their leverage is only moderate and supported by strong liquidity.

Image Source: Author.

Conclusion

They had a solid first half of 2021 but it still remains concerning to see their capital expenditure increasing by such a sizeable extent due to inflationary pressures. Since these pull back on their free cash flow and thus keep it broadly unchanged, it mitigates their higher earnings guidance and thus investors have a reason not to get too excited. Whilst this is not ideal, I still believe that my bullish rating is appropriate due to their forecast double-digit free cash flow yield.

Notes: Unless specified otherwise, all figures in this article were taken from SunCoke Energy’s SEC Filings, all calculated figures were performed by the author.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.