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Notable Special Dividend Payout At Least $5.17-$5.83 Per Share, Returns Over 15%

|About: Warrior Met Coal (HCC)


Company is currently releveraging to pay out special dividends.

Liquidation converted first lien creditors to common stock holders (holding 36%).

Recent (4/13/2017) IPO of core assets from Walter Energy’s liquidation.

Warrior Met Coal (NYSE: HCC) was formed during the liquidation of Walter Energy and its core assets, No. 4 and No. 7 mines located in Brookwood, Alabama. Walter Energy filed for bankruptcy on July 15, 2015 after agreeing to a stalking-horse deal with its first lien lenders. On December 15, 2015 a global settlement with the first lien lenders and unsecured creditors’ committees was reached whereby the $1.25 billion stalking-horse credit bid for the core assets by the first lien committee was accepted with a 1% payout to unsecured creditors who would look to a future auction of the remaining assets for recovery. This deal was contingent on terminating the company’s collective bargaining agreement and pension obligations which was later accepted by the bankruptcy judge. However, the Chapter 11 bankruptcy and restructuring of Walter Energy became effectively a Chapter 7 liquidation as no buyers appeared in the subsequent auction and the stalking-horse bid by first lien creditors, “Coal Acquisition LLC,” became Warrior Met Coal (HCC) to take control of Walter Energy’s core assets.

HCC sells premium metallurgical coal priced at a premium to the Australian Low-Vol Index and at a historically slight discount/premium to the Australian Hard Coke Coal Index.[1] Metallurgical coal is used for the production of coke, the primary source of carbon for making steel. Demand for metallurgical coal is highly correlated to steel production.

Previously HCC paid out $600M in a special cash dividend of $11.21 per share on November 22, 2017 leaving HCC with $36M in cash and $136M in liquidity through the $100M ABL facility. This previous special dividend was funded by a combination of free cash flow from operations and $350M in Senior Secured Notes due 2024.

Given 2018’s management guidance on HCC fixed operating cost structure (SG&A is $30-$33M) and capital expenditures ($100-120M) with $31.5M interest expense, the company’s special IRS rulings which allow the NOLs from Walter Energy, the predecessor company, to carry forward, HCC pays 0% in cash taxes, and trailing-twelve-months (TTM) price appreciation in Low-Vol and Hard Coke Coal up 36%[2]; HCC will likely generate at least $87-$110M in cash during Q1 2018[3]. Also management guidance on the last quarterly call (2.14.2018) stated that HCC minimum liquidity on the balance sheet, including a $100M ABL facility, would be $100M. Subsequently (2.26.2018) HCC announced $125M in senior secured notes with the net proceeds earmarked for a special cash dividend of up to $350M. This gives the company at least $265M in liquidity to payout its special dividend while still maintaining its operating liquidity minimum. Since the special dividend announcement indicates payment on or prior to May 15, 2018, halfway through Q2, including ½ of a conservative Q2 estimate ($43-$55M in cash generated) HCC will likely have $308-$343M in cash available to payout a special dividend. Assuming HCC maintains the guided liquidity ($100M minimum) and historical cash on-hand ($35M), the next special dividend payout on or before May 15th 2018 will likely range from $273-308M or $5.17-$5.83 per share.

However, the trade setup to capture the dividend here bears risks.

When the first special dividend of $11.21 was announced on November 2, 2017, HCC closed the day at $26.78 offering a 41% special dividend yield. The day the special dividend was paid out, November 22, 2017 HCC closed at $29.88. Optimal dividend capture trading could’ve realized a 53% return. And shareholders that held through the ex-dividend and payout period to the next day when HCC closed at $20.40 would’ve realized an 18% return.

The next special dividend was announced on 2/26/2018 as intended, and not finalized, pursuant to consent from its senior creditors. While management referenced an ex-dividend date no later than May 15, 2018, management also signaled that the ex-dividend date may occur prior. 7-days after announcing the potential corporate event HCC is trading down from its 2/26/2018 close of $33.90. Applying the aforementioned calculations for dividend payout the prospective dividend yield offered was likely 15% and is now 16% from 3/5/2018 close. Of course at the high end of management guidance the special dividend payout offers $6.63 per share, a prospective 20-21% return.

The day prior to the 2/26/2018 special dividend announcement HCC closed at $32.00 per share (2/24/2016). Assuming that the market efficiently price in the dividend HCC appreciates to $37-$39 per share, and ex-dividend date falls back to around $32.00 where it is currently trading. Since Trump initiated the steel tariff trade war media storm HCC’s peer companies Alliance Resources (ARLP), Alliance Holdings (AHGP) and Ramaco (METC) have not been notably affected by any hypothesized slowdown in GDP or steel production. However future clarity on the steel tariff may affect the sector and HCC price settlement ex-dividend.

Additional background on Warrior Met Coal business operations and plans is provided here for further reference. Warriot Met Coal (HCC) is a large scale, low-cost U.S. based producer and exporter of premium metallurgical coal with an estimated production capacity of 7.3 million metric tons and forecasted capacity of over 8 million tons after 2018 capital expenditures. HCC operates two mines (No. 4 and No. 7) with over 110 metric tons of recoverable reserves and owns one undeveloped mine called Blue Creek Energy Mine that contains 103 million metric tons of recoverable reserves. HCC is a low cost highly flexible producer because of its ability to utilize longwall mining techniques on the thick coal seams of No. 4 and No. 7; its restructured collective bargaining agreement with the United Mine Workers of America; and its variable operating costs tied to the labor, royalties and logistics contracts that varies in relationship to the Australian benchmark prices for coke (Hard Coke Coal Index and Low-Vol Index).

[1] 10-K, Warrior Met Coal, 2017

[2] See Australian Coking Coal (PLATTS) Low Vol and Hard Coke Coal Futures

[3] Indicated by company filed 2017 financial statements, management guidance, and commodity prices

Disclosure: I am/we are long HCC.