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Praveen Chawla
Praveen Chawla
Articles (63) 

Warrior Met Coal: Right Out of the Schloss Playbook

This coal company meets the criteria of low price, balance sheet strength and low leverage

April 21, 2020 | About:

Walter Schloss (1916 - 2012) was a legendary value investor and a disciple of Benjamin Graham. While another student of Graham's, Warren Buffett (Trades, Portfolio), has evolved from his deep value roots to more of a GARP (Growth at a Reasonable Price), Schloss’s deep value style has fallen out of favor in the last 30 years as deep value opportunities have dwindled. Schloss’s strategy was to buy cheap stocks with strong balance sheets trading at multiple-year lows. This is more of a “cigar butt” style of investing.

With the current downturn, I think this strategy seems to be coming back. As the downturn progresses, we will likely see more opportunities crop up in this strategy. Schloss focused on tangible value and hard assets, like working capital and plants and machinery. He believed in taking a large number of small positions in these “cigar butts." His theory was that even if some of these stocks went under, some of them would be multi-baggers, and overall, the portfolio would produce outstanding results. Schloss was very successful in his strategy.

Following the recent market downturn, Warrior Met Coal recently popped up on the Gurufocus Walter Schloss screen. It's selling for below tangible book value, has low debt and generates lots of cash flow.

Warrior is a metallurgical coal producer and exporter, primarily to the steel production industry. Metallurgical coal differs from thermal coal, which is used for energy and heating, by its carbon content and its caking ability. It's a higher quality coal with greater carbon content than thermal coal, which is used as fuel in power plants. Caking refers to the coal's ability to be converted into coke, a pure form of carbon that can be used in blast (basic oxygen) furnaces. Thermal coal for power generation is on its way out in advanced economies due to pollution and greenhouse gas emissions, though it's still quite popular in developing countries due to its low cost.

Metallurgical-grade coal (aka met coal) has characteristics that make it ideal for heating and transforming into coke, the carbon source needed to make steel. Met coal is heated to over 1000 degrees Celsius in the absence of oxygen, and then quickly cooled in water or air to produce a hard, porous brick of carbon known as coke. The coke is fed into a blast furnace with iron ore and a handful of other ingredients to make molten iron, which is then mixed (alloyed) with other metals to make the many diverse types of steel that are the backbone of our everyday lives.

Around 770 kilograms of met coal makes 600 kilograms of coke, which in turn produces one tonne (1000 kilograms) of steel using a basic oxygen furnace. Basic oxygen furnaces are currently used to produce about 74 percent of the world’s steel.

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The company has mining operations in Alabama. With two operating underground mines, Warrior Met Coal has the operational capacity to mine about eight million tons of coal per year from more than 300 million tons of recoverable reserves from these mines. The company also has a second undeveloped location, "Blue Creek," which is expected to have another 144 million tons worth of reserves and is currently under development. Total mine-life is estimated to exceed 30 years. Warrior Met Coal became a public company as a result of a purchase agreement between bondholders and Walter Energy when it went bankrupt. Due to the restructuring, Warrior acquired the producing mines and began trading shares as a lean company with no legacy liabilities on its balance sheet and minimum debt.

Warrior is generating a lot of free cash flow from its current operations. It generated $402 million of free cash flow in 2019. In 2020, this will likely be less due to slowdown in demand. However, I believe demand should swing back as economies recover in 2021 and beyond.

Warrior Met Coal - Operating Cash Flow

Warrior does not have a long trading history, as it became public only in 2017. For the first time in its brief history, it is trading below tangible book value as of April 20.

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Apart from a regular five cents quarterly dividend, Warrior pays out special dividends when market conditions warrant. Warrior has paid out a total of $22.70 per share in dividends since its IPO in 2017.

Its financial condition is strong with low leverage and good liquidity. Warrior had federal and state Net Operating Losses of approximately $785.6 million and $860.3 million, respectively, from its pre-bankruptcy days, and it does not expect to pay any federal income taxes for the next six to eight years. Thus, I believe Warrior Met Coal is a diamond being sold for the price of a lump of coal.

Disclosure: author is long Warrior Met Coal stock.

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