Arch Coal, Inc. (ARCH) Q3 2018 Earnings Conference Call Transcript
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ARC Capital Holdings Ltd. (NYSE: ARCH)
Q3 2018 Earnings Conference Call
Oct. 23, 2018 10:00 a.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Good day and welcome to the Arch Coal third-quarter 2018 earnings conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Deck Slone, Arch's senior vice president for Strategy and Public Policy. Please go ahead.
Deck Slone -- Senior Vice President for Strategy and Public Policy
Good morning and thanks for joining us. Before we begin, let me remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, may be considered forward-looking statements according to the Private Security Litigation Reform Act. Forward-looking statements, by their nature, address matters that are, to different degrees, uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the SEC, may cause our actual future results to be materially different than those expressed in our forward-looking statements.
We do not undertake to update our forward-looking statements whether as a result of new information, future events or otherwise, except as may be required by law. I'd also like to remind that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have posted in the Investors section of our website at archcoal.com. With me on the call this morning are John Eaves, Arch's CEO; Paul Lang, Arch's president and COO; and John Drexler, our senior vice president and CFO. We will begin with some brief formal remarks and thereafter we'll be happy to take your questions.
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John?
John Eaves -- Chief Executive Officer
Thanks, Deck. Good morning, everyone. I'm pleased to report that Arch hit on all cylinders during the quarter just ended. We delivered our strongest quarter of EBITDA since emergence, captured robust margins at our coking coal operations, demonstrated strong cost control in both our Thermal segments, saw record percentage of Other Thermal business in a tight seaborne marketplace, and had the opportunity in the PRB to shift significant incremental turns despite unusual wet summer weather in the region.
In short, it was an excellent quarter by virtually every measure. And just as importantly, we put the result in free cash flow to excellent use by driving forward a successful and ongoing capital return program. On the buyback front, we repurchased nearly 900,000 shares of stock, bringing total repurchase since the program's inception to 6.25 million shares. That represents just under 25% of shares outstanding at the program's launch, a highly significant achievement in just six quarters' time and a clear demonstration of Arch's compelling cash-generating potential.
In addition, we paid out $7.6 million in dividends during the third quarter and had now returned an incremental $48 million to shareholders in the form of recurring dividends over the same time frame. All total, we've now returned $544 million to shareholders via buybacks and dividends, which we view as a significant achievement. Given our confidence in the future of the business, we regard the capital return program as an excellent and value-enhancing use of free cash, and we remain sharply focused on driving continued progress on that front going forward. Before turning the call over to Paul for some additional color on our operating performance during the quarter, I will first share a few thoughts on the condition of coal markets.
I'm happy to report that in three of our four primary markets: seaborne coking, domestic coking, and seaborne thermal, the fundamentals are highly compelling already with good reason for continued optimization. In the fourth, the domestic thermal segment, we remain in recovery mode, but with improving outlook. Let's start with the coking coal markets. Globally steel demand is up nearly 5% year to date, a very robust growth profile and one that speaks to continued strong economic expansion in all global markets.
Next, steel demand growth has helped spur nearly 5% pickup in seaborne coking coal demand at a time when coking coal supply remains under pressure. While Chinese imports are lagging last year's levels modestly, Chinese steel and coke producers have consistently returned to the seaborne market, each time coking coal prices have retraced. And in the end demand continues to surge higher with the promise of significantly more growth in the coming decade. As we noted on past calls, investment in new coking coal production have been quite constrained in recent years, both during and in light of the most recent market trough.
The upshot has been very fragile supply network that is easily stressed as we've seen in the recent weeks and issues at several mines across the globe that serve to push prices much higher. Layer on to that supply challenges, an equally fragile logistics chain, and you have a recipe for continued strength in the coking coal markets. In addition, steel producers who are seeking to capitalize on the recent steel price strength are wringing out additional volumes at the mills. That tends to favor the higher-quality coking coals that can reduce coking times and facilitate higher utilization levels.
And at Arch, as you know, specializes in such products. The domestic coking coal market remained strong as well with capacity factors at U.S. steel mill standing at 80%, and idle mill capacity coming back online. As discussed in this morning's release, Arch has committed a higher percentage of our volume for delivery in this resurgent market in 2019, as Paul will discuss in a few minutes.
Turning now to the international thermal markets, robust demand around the world has lifted both Asian and European coal prices to very attractive levels on a historical basis. The Newcastle price is nearly $110 per metric ton for 2019 delivery and API-2 prices are nearly $100 per metric ton. That creates compelling export opportunities for our Colorado thermal coal off the West Coast and thru the Gulf, and for our West Virginia thermal coal off the East Coast. But it's also possibly generated for domestic thermal markets in that it pulls incremental volumes in the international markets.
We are currently projecting that thermal exports will increase by 15 million tons in 2018. That brings us to the domestic thermal marketplace, where we've seen price increases in some basins, particularly those with access to the export market. But as noted, the outlook continues to strengthen. Good summer heat and improving natural gas combined with higher exports have contributed much improved utility stockpile levels. We estimate the stockpile levels at U.S.
power plants are now at their lowest level in four years on a days supply basis. That should translate in an improved demand and pricing over time. In summary, we're pleased with our ongoing progress and expect to continue to generate strong levels of cash flow as we progress into 2019. We are executing at a high level in all three of our business segments, capturing the full value available to us in a resurgent marketplace and following our clear improvement plan for returning capital to our shareholders in a highly value-creating way.
We see more good times ahead for Arch and more good times ahead for you, our shareholders. With that, I'll now turn the call over to Paul for further thoughts on our third-quarter performance. Paul?
Paul Lang -- President and Chief Operating Officer
Thank you, John, and good morning, everyone. As John mentioned, our third-quarter performance was strong across the board with excellent execution at our mining operations. We had another meaningful top-line performance from our metallurgical segment. We saw opportunistic shipments in the Powder River basin and continued robust sales activity into the seaborne market by Other Thermal business.
At the same time, the marketing team made excellent progress as it continued to build a strong order book for 2019. This was especially true in our coking coal segment. In short, we delivered great value in the current year while setting the stage for what we expect to be another strong performance in 2019. In the metallurgical segment, our portfolio of large modern coking mines ran well again turning in another strong cost performance, which was right at the midpoint of our annual guidance range.
As mentioned in the release, we have a small degree of cost inflation in recent months, the most notable of which has been higher steel prices flowing into material cost, such as roof bolts and plates. Even with this, the mines continue to do an excellent job with cost containment, and we believe our cost structure remains comfortably in the first quartile of the U.S. cost curve. Turning to the quarter just ended, we shifted 1.7 million tons of coking coal, consisting of 1.2 million tons to seaborne customers, and 500,000 tons to North American customers.
Within this, we again delivered impressive margin, averaging over $42 per ton or 40%. That's roughly equivalent to the average margin captured in the second quarter despite the fact that during the third quarter, we shipped a higher percentage of High-Vol B in North American volumes at prices that were fixed in late 2017 during a less favorable market environment. We also put to bed 2.9 million tons of 2019 business during the quarter with roughly half that total being placed with North American customers. In the past, as you know, the vast majority of North American business has been done on a fixed-price basis.
This year we've had certain North American customers who are open to a more market-based pricing structure, similar to those that dominate the seaborne market. As a result, we sold two-thirds of our North American volumes, around 1 million tons, on an index-linked basis. As for the remaining 500,000 tons, we committed those volumes at nearly $125 per ton or roughly $25 higher than our average 2018 fixed price for North American business. In addition, we committed under 1.4 million tons for delivery to seaborne customers in 2019, all of which is on market-based pricing.
As previously stated, we're comfortable with both fixed and market-based pricing mechanisms. And those instances where we can secure fixed pricing that fully reflects the value of our products, we're happy to lock in such sales. When that's not possible, we have the strength in our balance sheet and are equally comfortable selling on an index-linked basis. In total, Arch has now signed commitments for 4.6 million tons of coking coal for delivery in 2019, roughly 87% of which is subject to market-based pricing.
Looking ahead, we anticipate coking coal volumes in the fourth quarter to be comparable to the third as an improving logistics chain is expected to be offset by a planned long-wall move at the Leer Mine as well as routing export vessel slippage at the end of the year. We are now forecasting the longwall move at Mountain Laurel, mentioned in our last call, will fall in the first quarter of 2019. In the Powder River basin, our operations rose to the challenge during the third quarter, overcoming unusually wet summer weather and capitalizing on incremental train availability to deliver exceptional results. Volumes increased 14% over a strong Q2 shipment level and cost declined by $0.90 to $9.76 a ton.
With this, our margins increased to impressive 60% versus Q2 to $2.26 per ton. Again, all around great work by the Thunder basin team. We also placed additional Powder River Basin volumes for delivery during the remainder of 2018 as well as the outer years, while the market price for Powder River basin coals lag in other regions of present, due in part to the absence of a meaningful export outlook, we are comfortable with our position. For 2018, we've committed and priced a total of 77.2 million tons at an average of $12.01 per ton.
For 2019, we committed 39.5 million tons at an average price of $12.33 per ton and have another 1.4 million tons committed at indexed pricing. I'd like to add that market activity has picked up considerably since the end of the quarter, which is both encouraging and positive. Consequently, we'd anticipate reporting a significant increase in our 2019 committed position at the time of our next update. Looking ahead, we anticipate that volumes will be appreciably low in the fourth quarter due principally to the acceleration of shipments over the last five months.
As you would expect, those lower volumes during the fourth quarter will translate into a predictable increase in our average cost during the period, but still comfortably hitting our annual cash cost guidance range. There's one other notable development in the Powder River basin that I'd like to highlight before moving on to the Other Thermal segment. We're currently finalizing our revised mining and reclamation plan at Black Thunder that should reduce the mine's asset retirement obligation on a discounted basis between $90 million and $110 million. The new plan integrates our existing pre-strip activities with our reclamation plan in a much more coordinated fashion.
This revised plan will accelerate reclamation during the ordinary mining process and at the same time should not have any impact on our operating cost for the mine. This change will represent an approximately 30% decrease in Arch's total ARO liability and further strengthens our comparatively low legacy liability position. Arch has always made a point of keeping our long-term liabilities at a minimum across the operating platform, including the aggressive reclamation of idle properties. This change in the plan of Black Thunder simply represents good business and ongoing prudent housekeeping.
In our Other Thermal segment, exports again were the story as we continue to place a high percentage of our volumes into a tight seaborne market. During the third quarter, we exported approximately 1.3 million tons from our West Elk and Coal-Mac operations. We also capitalized on logistic chain improvements, particularly on movements off the West Coast, which had boost segment volumes by roughly 25%. Included in our export shipments were two vessels that have slipped out of the second quarter into the third quarter.
These higher volumes combined with solid cost control helped deliver an 11% reduction in our average per ton cost for this segment. This in turn helped drive a 66% increase in our cash margin per ton quarter over quarter. For Q3, this segment delivered a cash margin over $9 or 25%. Looking ahead, seaborne prices remain elevated and there continues to be a high degree of interest in both our West Elk and Coal-Mac products internationally.
At the same time, domestic interest has also increased which is encouraging. The cost of segment we placed 3.9 million tons of business for delivery in 2019 at a price of about $40 per ton and are close to locking down another significant tranche of both domestic and seaborne volumes in the fourth quarter. In closing, we're pleased with Arch's performance in the third quarter. The mines ran exceptionally well.
And our strong commitment to safety and environmental stewardship was again on display as Arch took home a Sentinel safety award for our Coal-Mac preparation plant. We believe we set the stage for a solid end to 2018 and a strong 2019. With that, I'll turn the call over to John Drexler, who will provide an update on Arch's financial position. John?
John Drexler -- Senior Vice President and Chief Financial Officer
Thanks, Paul, and good morning, everyone. As John and Paul have discussed, our low-cost met and thermal operations continued to generate healthy levels of cash during the third quarter and we continue to return that cash flow to our shareholders. During the quarter, we repurchased $76 million of stock, buying back nearly 900,000 shares at an average price of $87.59 per share. Since the inception of our capital return program during the second quarter of 2017, we have now bought back almost $500 million of stock or 25% of our shares outstanding at an average price of $79.68 per share.
As of September 30, we have $255 million of capacity remaining under our $750 million authorization. In addition, we paid our normal recurring dividend during the quarter, bringing total dividends paid under the capital return program to $48 million. Between our share repurchases and dividends, and as John mentioned, we have returned a total of $548 million of capital to our shareholders. As we look ahead to the remainder of the year, given our current capital resources and the expectation of strong free cash flows, we expect to continue to drive forward with our robust proven share repurchase plan.
Additionally, the Board of Directors has approved the next quarterly dividend payment of $0.40 per common share. That dividend will be paid on December 14 to stockholders of record as of the close of business on November 30. Turning to the balance sheet and our liquidity position. At September 30, we had $408 million of cash and short-term investments. Combined with our unused borrowing capacity under our two short-term borrowing facilities: our AR securitization facility and inventory-only ABL, we have $432 million of total liquidity.
As a reminder, we have to date primarily utilized these facilities to issue letters of credit supporting various obligations necessary in our industry. Subsequent to the end of the quarter, we successfully amended our AR facility to allow for additional borrowing capacity in excess of our expected letters of credit requirements. The amendment also extended the term of this facility to the third quarter of 2021 and decreased the fees on borrowings and the issuance of letters of credit. On a pro forma basis at September 30, had this amendment been in place, we would have had approximately $465 million of liquidity.
With the increasing committed unused borrowing capacity in our AR securitization facility, we would be comfortable allowing cash to fall below the $400 million level. Still it's important to point out that given the liquidity needs and the requirements in our cyclical industry, cash will always be an important component of our liquidity. Consequently, we will remain intensely focused on maintaining our industry-leading balance sheet. As Paul mentioned in his remarks, we continued to make -- take advantage of an improving international thermal market by layering in swap positions to lock in pricing on select volumes for delivery in late 2018 and 2019.
Some of these swaps are not eligible for hedge accounting, and thus our marked to market on the income statement. As a result, as international thermal pricing continued to strengthen over the course of the quarter, we recorded loss on all of our swap positions of $10 million. These positions will continue to be marked to market through the income statement until their expiration, but ultimately any losses incurred on the swaps will be offset by higher pricing on the physical shipments. At September 30, we had a total portfolio of swaps for 1.6 million tons associated with this program, with the majority for volumes that will ship in 2019.
Another significant development during the quarter was the recognition of a $45 million tax benefit. The benefit primarily results from the recognition of additional AMT credits associated with the modified tax position that we filed during the third quarter with the IRS. We expect the AMT credits to convert to cash over the next five years. We continue to expect our tax rate to be effectively zero for the foreseeable future.
Our 2018 guidance is reflected in the press release and Paul has provided thoughts on our sales and operating cost outlook. A few of additional items to note. Our depreciation, depletion, and the amortization expenses are now expected to be between $118 million and $122 million. The increase from last quarter's midpoint is primarily driven by the increased shipments in the Powder River basin.
We now expect our SG&A expenses to be between $93 million and $96 million. This includes $15 million of noncash equity compensation expense. This increase of $2 million at the midpoint from last quarter primarily stems from additional accruals for employee incentive programs. In addition, we now expect our net interest expense to be between $13 million and $15 million.
The reduction from last quarter is primarily driven by the benefit of increased interest income from rising interest rates. To conclude, we remain intensely focused on executing our plan to operate our Tier 1, low cost, well-capitalized met and thermal franchises to generate strong cash flows. And we remain exceptionally well-positioned to continue our capital return program. With that, we are ready to take questions.
Operator, I'll turn the call back over to you.
Questions and Answers:
Operator
Thank you. [Operator instructions] Our first question comes from Jeremy Sussman with Clarksons.
Jeremy Sussman -- Clarkson Capital Markets -- Analyst
Hi. Good morning and congratulations on a very solid quarter though you guys certainly picked quite a day to come out with such solid seven numbers.
John Eaves -- Chief Executive Officer
Yes. Thanks, Jim. It's a little messy out there today.
Jeremy Sussman -- Clarkson Capital Markets -- Analyst
Yes, it's a tough one today. Look, let me just start on the annual domestic met contracts. I think the fixed portion of 124, 44, I guess, what -- first, what quality is that? And then secondly, in the -- in your prepared remarks, you noted that you have about 1 million tons of market-based domestic pricing, which is a bit of a change, I guess. Can you just kind of talk about how that dynamic came about?
Paul Lang -- President and Chief Operating Officer
Yes. Jeremy, on the committed North American sales, it was obviously products, but it was probably weighted a little heavier toward the High-Vol A and High-Vol B with a little bit mix of Low-Vol. As far as the -- kind of the change in strategy with some of our customers, I think we all are facing this question of where the prices are going to be. And what we saw was particularly the multinational steel companies that have U.S.
operations were much more comfortable looking at an index-linked contract. And we felt very comfortable doing it also and hence we came together, and we think it's a little bit of a unique for our North America business, where we have about 1 million tons index-linked.
John Drexler -- Senior Vice President and Chief Financial Officer
Yes. Jeremy, this is John. I guess, as Paul and his team sit down with our domestic steel customers, I mean, we're used to them locking into volume and price for the year. But as Paul said, we had some customers that indicated interest in doing differently.
So, when we look at the market, we saw the international markets and the index is above what we were seeing domestically, and since that time, that continues to move higher. So, if you look at Platts this morning and just take High-Vol A , for instance, it's $215. You convert that back to short and pull out transportation, you can even use $35 to $40 transportation. You still get somewhere between $155 and $160 at the mine.
So, we think we've made a prudent decision. Can those prices retrace a little bit? Absolutely. But given where we are today, we feel pretty good about the decisions we've made.
Jeremy Sussman -- Clarkson Capital Markets -- Analyst
No, that's super helpful color and that sounds great. And maybe just a quick follow-up. So you've bought back 25% or so of your stock, which -- over the last six quarters, which is obviously quite impressive. With that said, is there a point where you would be worried about the floater, a trading volume with -- to maybe push you more toward the higher dividend route? I'd just to be curious how you kind of weigh this dynamic?
John Drexler -- Senior Vice President and Chief Financial Officer
Hey, Jeremy, this is John Drexler. And clearly, our execution on the share repurchase program continues to show great confidence that we have in what we see with our ability to generate cash, and what we see our ability to generate value. Your questions, one, is constantly evaluate. But as we sit here today, with the opportunity that we see moving forward with where we see the shares at today, with where we see our market conditions, our ability to generate cash, I think we've been very clear with our plans that we'll move forward.
Now, as we move forward, that's something that's always under constant consideration. But right now, I think we've been quite clear what our plans are as we move forward in the current environment.
John Eaves -- Chief Executive Officer
And, Jeremy, this is John. I mean, we're always having those discussions, as John said, with our board. And we look at the dividend and the share buybacks has been great value-enhancing vehicles but I mean, it's something we always look at. I don't know that we're getting any feedback that liquidity is an issue right now in the market.
At that time, when we do get that feedback, certainly we'll have discussions about but right now we think those two vehicles create the most value for Arch Coal.
Jeremy Sussman -- Clarkson Capital Markets -- Analyst
That's very helpful. Thanks very much and good luck.
John Eaves -- Chief Executive Officer
Thank you.
John Drexler -- Senior Vice President and Chief Financial Officer
Thank you, Jeremy.
Operator
Thank you. Our next question comes from Mark Levin with Seaport Global.
Mark Levin -- Seaport Global -- ANalyst
Hey, great. Again congratulations on another terrific quarter. Couple of quick questions. One relates specifically to the PRB, just kind of thinking about Q4 relative to how you -- what you guys did in Q3.
It looks like the guide implies maybe 13 million to 17 million tons of PRB volumes in Q4, which is obviously a pretty big drop from Q3. Is that right? Is that the magnitude of the decrease? And how -- just want to make sure that that's the right way to think about it.
John Drexler -- Senior Vice President and Chief Financial Officer
Yes. Mark, I think you're -- clearly you got the range correct. What I'm concerned about is -- yes, we obviously shift very well last five months, and we know exactly what we are doing and it in turn translated, I believe, into additional sales, not only in 2018 but 2019. And I think we went into it knowing that we may give a little bit back in Q4, but net-net, I think we're going to come out of this very well ahead.
John Eaves -- Chief Executive Officer
At the same time, Mark, we didn't really bring any 2019 volumes into 2018 either. So, we feel pretty good about that.
Mark Levin -- Seaport Global -- ANalyst
Great. No, that's perfect. Just to clarify, on 2019, so when we think about the book going into 2019, and we look at maybe just assuming met is flat, shipments in 2019 over -- 2018, I realized you haven't given guidance, but just making that assumption, what percentage of the overall book, met coal book, do you expect to have fixed price -- annual fixed-price contracts on going into next year? I think it was 20% this year. What would be the number be in '19?
Paul Lang -- President and Chief Operating Officer
Mark, I think, it's going to be less than 10%.
Mark Levin -- Seaport Global -- ANalyst
OK. Got it. And then related to cash cost in 2019 on met coal. So, a couple of things, one would be -- you referenced maybe some raw material inflation, you didn't reference labor inflation, but you referenced raw material inflation.You'll comp against, I guess, Mountain Laurel and the geologic issues that you had in the first quarter, and hopefully there won't be any next year. Should we continue to think about met coal cash? Or should I continue to think about met coal cash cost being down year over year in 2019 over 2018, considering -- assuming there's no further geological issues?
Paul Lang -- President and Chief Operating Officer
Yes. That's a -- obviously, it's a little early to talk about '19. But I think, as you look at Q2 and Q3, you get a good sense of where we're at. The other thing I'd point out to you is that what I look at, because it's a high-class problem, and look, if prices are much as they are, and we think they could in '19, that does have a corresponding impact on cash and royalties.
Mark Levin -- Seaport Global -- ANalyst
Sure. And then last question -- I'm sorry. Go ahead.
John Eaves -- Chief Executive Officer
[Inaudible] We are in the budgeting and planning phase right now, and hope we can update you more on that when we report fourth quarter in early February. But what we have said a couple of times in previous calls is it seem layer thickens out in 2019 and actually thickens out even more as we move into 2020, which would imply better costs there over time.
Mark Levin -- Seaport Global -- ANalyst
That's great. That's a good point. Last thing I was just going to ask, there was a high-profile bankruptcy in sort of the U.S. met coal market that was announced over the last couple of weeks.
When you think just very generally, John, about strategy, is there a point at which you look out at what's available in the marketplace and you say, "You know what
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