Selling Consol Energy Stock To Buy Other Coal Names (NYSE:CEIX)

Overview

Consol Energy (NYSE:CEIX) is a 150-year-old producer of thermal and met coal. The company has the best thermal coal assets in North America and their flagship operation, the Pennsylvania Mining Complex (“PAMC”), produces ~28.5 million tons of coal per year. PAMC is served by two railroads, and Consol Energy also owns their own coal terminal in Baltimore. The estimated reserve life at PAMC is over 20 years. It is important to note that Consol Energy mines a low sulfur coal that can be blended for industrial uses. As such, the company’s percentage of sales to domestic power generation has decreased from 61% to 27% since 2017.

Export Focused

Consol Energy has radically changed their focus towards the export market over the last three years. The company has quite rightly noticed that thermal coal demand in the United States is in structural decline. Therefore, the company has transformed themselves in to an export powerhouse. 71% of revenues in 2023 came from the export market. Contrast that with only 33% of revenues coming from the export market in 2018.

Q4 2023 Results

On February 6, 2024, CEIX reported their Q4 and full year results. For the most part, earnings were in line with expectations.

Revenue increased 1.9% Y/Y to $649.4M. The company also reported GAAP dilutive earnings per share of $5.05. Finally, the company reported quarterly free cash flow of $165.0 million. Perhaps the only questionable part of the earnings report was how much money was spent on buybacks vs debt repayment. We’ll get to that later in the article.

The stock has been in a downtrend since the late fall and has pierced the 200-day moving average.

2024 Guidance

Fiscal year 2024 guidance was also in line with expectations. The company forecasts PAMC coal sales volume of 25.0-27.0 million tons. The average realized revenue per ton sold is expected to be in the range of $62.50-$66.50 versus an average cash cost of coal sold per ton expectation of $36.50-$38.50. The company is 87% contracted for 2024 meaning that there should not be any revenue surprises. However, it is important to note that the company has only contracted for 51% of production for 2025.

If one is to look at the Rotterdam coal futures for 2025 it is not a particularly bullish chart. The mild winter weather and high inventories have smashed prices lower. Unless there is a scorching hot summer, I’m concerned that 2025 revenues could surprise to the downside.

Obviously, the Russian embargo created a huge short term spike that benefitted CEIX greatly. However, going forward, I’m concerned that earnings will normalize in the $500-600 million dollar range.

Finally, the company forecast total capital expenditures of $175-$200 million, roughly in line with 2023.

Smart Money Value Investors Own CEIX

Consol Energy is unique among coal names in that it is found in the portfolios of “smart money” value investors. As of December 31, 2023, CEIX was David Einhorn’s second-largest holding at 10.34% of his portfolio. It should be noted that he has been reducing this position over the last two quarters.

Similarly, value investor Mohnish Pabrai has a 14.95% position in CEIX as of the last reporting date. He has also reduced this position size from 24.53% of his portfolio in recent months.

Both Einhorn and Pabrai have noticed that share buybacks are a crucial catalyst for value stocks such as CEIX to unlock value. A couple of years ago, Einhorn pivoted to buying companies with sizable buyback programs in place, instead of simply purchasing cheap stocks that were struggling to close the valuation gap. In his Q2 2022 investor letter he stated, “We aren’t relying on other active investors to buy the stocks that we own, so we instead are choosing to emphasize investing in companies that appreciate this dynamic and are creating value both through their operations and through buying back their own stock at very low prices.”

Pabrai gave an interesting presentation on the power of buybacks, “How share BUYBACKS can 10x or more your investments”. Since CEIX is not a beneficiary of being included in many ETFs or other passive investing vehicles, (ETF’s own ~33% of the company) it is crucial that buybacks are used to close the valuation gap.

Buybacks and the Balance Sheet

Consol Energy has committed to allocating 75% of free cash flow to either buybacks or dividends. The current dividend yield is 5.34%.

On the most recent conference call, management noted that they elected for buybacks versus debt repayment.

“We generated $858 million of cash flow from operations, of which $168 million was used towards capital expenditures and $687 million was available as free cash flow. Of the $687 million, 28% was deployed towards debt repayment, and 68% towards shareholder returns. These together translates to approximately $22 a share based on our year-end, 2023 share count.”

As you can see, the company has radically bought back shares over the last year and this continues to be the plan going forward in 2025.

Some may question why the company continues to carry $186 million of debt while they used $467 million on share buybacks. Given that the shares were re-purchased at ~$100/share versus the current $85 share price, some investors are rightly puzzled by the capital allocation decision. However, as I’ve mentioned above, a number of value investors are adamant that free cash flow machines with little ETF ownership need to buy back shares rather than pay down debt.

Valuation

Consol Energy has an enterprise value of $2.4 Billion. Consensus estimates for 2024 EBITDA is $790 million. The consensus forward EV/EBITDA ratio is about 3.1X. Certainly, on that metric, you cannot say that CEIX is overvalued.

However, I’m more concerned with 2025 pricing, where I can see earnings normalize in the $550 million range. That would give CEIX an EV/EBITDA ratio of 4.4X. Although that does not seem rich by general market valuations, it is not particularly cheap for the coal industry. I can rotate into some met coal producers with a 3X EV/EBITDA ratio that I think offer me more upside.

It is possible that the existing inventories of thermal coal will be depleted if there is a major heat wave, primarily in Europe. This past winter season was unexpectedly mild, and thermal coal prices traded at levels seen five years ago. In addition, there is always the threat of more Russian embargoes or geopolitical tensions that can upset the seaborne thermal coal market and cause prices to rise. These are upside catalysts that could negate my sell rating.

Conclusion

I’m looking to tilt my portfolio more towards pure play Met Coal producers that I will cover in future articles. Although CEIX has deftly navigated the structural decline in domestic thermal coal demand, there are other coal companies that I find more attractive at this time. I suspect that shares of Consol Energy could trade in the $70-90 range for the next year (4X EV/EBITDA) unless there is a huge summer heat wave that dramatically clears existing inventory and boosts thermal coal prices. For that reason, I have just sold my shares of Consol Energy and I will allocate the proceeds to other coal producers.