Last month, I published my analysis of the NACCO Industries spin-off investor presentation from last year. Today, I’ll be sharing my notes from the most recent NACCO earnings call which took place on May 3rd, 2018. This quarterly earnings call covered the business results for NACCO Industries in the first quarter of 2018. The earnings call recording and first quarter press release are available here in the investor relations section of NACCO’s website.
My goal is to provide you with insight into my process of performing fundamental analysis. As I am sharing my notes in this post, you will gain the most value by doing your own investigation of the company. Perhaps these notes can be used as a means of comparison and to provoke ideas.
The First Quarter of 2018 NACCO Earnings Call
The first thing to note about the NACCO earnings call is that they generally aren’t that useful. Management’s prepared remarks are generally a near word-for-word reading of their earlier press release. I’ve now listened to the Q3 2017, Q4 2017, and now the Q1 2018 NACCO Earnings calls. I have found this pattern to occur in each of these calls so far.
This isn’t necessarily true with every company, but it’s generally been true with NACCO. It’s one thing you want to be aware of when choosing to spend time listening to an earnings conference call. Most of the time, the true value comes from analyst questions, assuming the analysts even ask good questions.
I specifically chose not to share my notes from the first two conference calls I listened to because they weren’t particularly useful. Fortunately, this call was quite useful. A new analyst was on the call this time, and they asked six useful questions.
A brief discussion of NACCO’s First Quarter 2018 Earnings Results
Before I dive into the analyst questions, I’ll note a few things that I observed from the press release and my own additional analysis.
Q1 2018 earnings for the unconsolidated mines increased by 4% year over year. This is critical because the entirety of the value of the company comes from their unconsolidated operations. Although the rest of the company is profitable, only the unconsolidated mines have exceptional earnings quality.
Otherwise, net income was flat from Q1 2017 to Q1 2018. This disguises the true growth though because, in Q1 2017, there were one-time earnings that distort the figures. So, even though results don’t show it, this company is in growth mode.
NACCO ended the first quarter of 2018 with a net cash position of $32.6 million. This is good news. They continue to have a growing net cash position. Remember that Enterprise Value is equal to Market Cap minus Net Cash. Basically, the company is cheaper than it appears on simple earnings per share basis. If you purchased the whole company, you’d own the business and the net cash.
NACCO repurchased zero shares in the first quarter of 2018
This isn’t exactly surprising, albeit it is disappointing. In February, the board of directors announced a $25 million stock buyback program that lasts through the end of 2019. This is enough to repurchase nearly 10% of the company’s outstanding shares. As NACCO seems undervalued right now, it would be beneficial for shareholders if management repurchased shares.
Hopefully, the delay is simply because the approval only occurred in February. In an ideal situation, NACCO would be aggressive in their repurchases. However, if we simply assume they execute the whole program by the end of 2019, then we should expect 5% of outstanding shares to be repurchased each year for the next two years. That’s quite attractive on its own. Although, we’d have to take into account any shares issued to management as compensation.
First Quarter 2018 Financial Results and Outlook for 2018
Basically, the outlook hasn’t changed since management originally presented guidance for 2018. Income is expected to be steady, neither increasing or decreasing. Meanwhile, capital expenditures are expected to be high because of the need to replace equipment at the consolidated mine.
For some people, this seems concerning, but I’m not concerned. The consolidated mine is profitable, and we have to expect these lumpy capital expenditures over time.
Analyst Questions prove to finally be useful
This conference call Q/A portion was a breath of fresh air. After listening to the previous calls, it was obvious that the few analysts that chose to call in didn’t really understand how this company operates. This call was different.
Only one analyst called in to ask questions, but they asked quite a few. I’m going to break down the six questions, and the key answers. These won’t necessarily be direct quotes, but some of them might be. When I listen to conference calls, I basically transcribe anything I hear that sounds useful. If I’m not transcribing, I might instead simply jot down a few notes from what they say.
I just wanted to give that caveat because some of the wording is likely management. So the source of any answers is from the NACCO earnings call which I linked to above. Any added emphasis is obviously my own.
Question 1: Camino Real Contract Renewal
Answer: This contract is a customer contract. It’s a management fee arrangement. NACCO mines the coal for the customer. However, it’s the customer’s coal that is mined. NACCO doesn’t own the coal, they simply receive a service fee. Consequently, NACCO has no control over the whether or not the contract will be extended. This is a negotiation between NACCO’s customer and the power plant that uses the coal. NACCO management plans to operate the mine as if it will be continued in the future.
My notes: I wonder how many of NACCO’s mines are like this? I was under the impression that most of NACCO’s contracts were direct with the power plant as the customer.
Question 2: Margin comparison between Limestone mining business in Florida and Unconsolidated Coal Mines
My notes: This is really the only bad question which the analyst asked. Listen to the conference call if you want more in-depth of an answer. I’ve taken note below of the only useful part of the answer.
Answer: Revenues on the unconsolidated mines are equal to 100% of the costs incurred at those mining operations plus NACCO’s management fee.
Question 3: Do you expect aggregates to continue to be a material part of the business?
Answer: In short = yes. Both the coal business and the lime rock aggregate mining businesses have been growing recently. The lime rock business in Florida has grown particularly fast recently. A lot of new customers have been added and it helps that the economy is booming. A booming economy means that lime rock is in higher demand. Therefore, lime rock miners expand their operations giving us an opportunity to grow the business.
However, NACCO provides a very specific service the lime rock industry. A company has lime rock reserves. These reserves are mined and then the lime rock producers do all of the additional value-added services. NACCO is only participating in the mining portion and even then only a small part of the value chain.
My notes: Growth is good, and it’s nice that NACCO is benefiting from this growth. One caveat though seems to be that this growth has been driven by higher demand from a strong economy. This could all turn around in a recession. Not as good.
Question 4: Future Capital Allocation Plans (My Favorite Question)
Answer: We are investing in growth. Operating expenses are up because of business development activities. We intend to maintain very conservative leverage. We like that we have very little debt. NACCO has paid dividends for a very long time. I have been around for 22 years. We have had a number of programs to buy back shares. Those are really our priorities in order.
- Low Leverage (Pay down debt or keep a low level of debt)
- Consistent dividends
- Buy Back Shares
I’m okay with this priority order. First should always be to invest in the business. If growth opportunities exist that is good. This is not an ideal business for that if growth is in consolidated mines though, because they have a low return on capital. However, if growth is in the unconsolidated operations that is very good for shareholders.
Low leverage is always nice because it reduces the risk of bankruptcy. However, NACCO could probably increase leverage from here. I don’t want them to be paying down debt because it’s a low return on capital activity with interest rates being so low. If they want to simply keep current debt that’s acceptable, but not ideal.
I’ll never argue with consistent dividends, and I’m glad they’re planning to buy back shares. If I were running the company, I’d probably buy back shares much more aggressively than they have announced but at least they are moving in the right direction.
Question 5: Why not a larger dividend?
Answer: We want to be prudent. We want some dry powder for what might come up in the future. We have seen other mining companies have issues. NACCO signed a 40-year contract to operate the Liberty mine. Well, it didn’t work out and the facility was shut down. We thought we’d make a lot of money from that mine, but it didn’t pan out.
One of our advantages with growth is that we are very stable. They (the customers) don’t have to worry about us being here next year or not.
My notes: I love hearing when management uses the word prudent. Acting prudently is exactly what I want management to do. Also, I wanted to highlight the fact that NACCO’s management is emphasizing their stability. That’s probably the best thing I like about the company. Stability benefits both customers and shareholders.
Question 6: Does your large cash balance mean you’re considering an acquisition?
Answer: It’s impossible to predict the future.
My notes: This is clearly the best answer from the call. Obviously, management won’t discuss future acquisitions. I like though how they aren’t trying to predict the future to please shareholders. Shareholders don’t need management to predict the future for them. It’s even best when they don’t even try.
NACCO Earnings Call Summary
This was a very good NACCO earnings call to learn about how management thinks about their business. It’s definitely encouraging when management seeks to be prudent with shareholder capital.
I continue to gain confidence in NACCO’s leadership.
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