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Blackhawk CFO sees M&A potential for metallurgical coal space in 2018

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Blackhawk CFO sees M&A potential for metallurgical coal space in 2018

? 2018 could be a year of mergers and acquisitions in the metallurgical coal space.

? Company expects metallurgical coal rally to continue this year.

? Coal supply picture fundamentally changed since wave of bankruptcies that swept through the sector.

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Jesse Parrish is the CFO of Blackhawk Mining LLC, a diversified mining company headquartered in Lexington, Ky.

Blackhawk Mining LLC was formed in 2010 and produced just over 1 million tons of coal in its first full year of operation. The company has since grown rapidly and expects to produce 14.5 million tons in 2018 despite a decline in overall coal production in the U.S. Through a series of deals, including scooping up assets from bankrupt companies, Blackhawk is now a leading producer of metallurgical coal.

S&P Global Market Intelligence talked to Blackhawk Mining CFO Jesse Parrish about Blackhawk's strategy that survived rough coal markets and what that plan looks like going forward. This is an edited transcript of the interview.

S&P Global Market Intelligence: What do you think will be a trend to watch in the coal sector this year?

The biggest thing to be on the lookout for in 2018 is you have a lot of unnatural owners of coal companies, particularly metallurgical producing coal companies that are all generally either private or not widely traded equities. Where equity multiples continue to trade at discounts to historical levels, it leads one to believe the only way for folks to gain liquidity and gain access to capital markets is consolidation. 2018 looks, potentially, to be a year for that sort of consolidation to take place.

You once said Blackhawk was a company that "grew up in tough coal markets" and that made you better equipped to survive what the coal industry has gone through in recent years. How has that strategy played out?

Blackhawk, at the end of 2013, was producing about 3 million tons of coal a year, nearly all of which was Central Appalachia thermal coal. We realized that we needed to diversify our company in order to deal with the systemic changes that were occurring with that product line.

As part of that, acquiring assets in down markets and having to grow in down markets, it's taught us to be very good stewards of our resources and to basically try to recapitalize our mines, equipment and infrastructure with components and parts we have available. We now operate a facility in Hazard, Ky., where we rebuild quite a bit of our own underground mining equipment.

We try to be very lean from an operational management structure. The idea is that folks that are not working at the mines and producing coal, at the end of the day, are a cost to the company. We strive to maintain that lean structure and even though markets have improved since those times, late '15/early '16, those core principles are still very much about what we do.

I believe we have the flexibility to meet whatever the market dynamic is because ultimately our focus will continue to be on producing safely and at the most efficient level so we can keep our cost fairly constant.

What are Blackhawk's expectations for metallurgical coal markets through 2018?

We think it is going to be a very strong year for metallurgical coal, particularly high-vol coals, which is what we produce. Global economic indicators are all very positive.

Demand for metallurgical coal in the U.S. as well is still very strong. Practically speaking, there are a number of what we believe are very real supply limitations on operating producers to be able to bring additional tons to market. We think those supply limitations will ultimately keep the market in balance, even though higher prices continue to exist, and thereby prolong the rally we've been experiencing for the last year.

How about thermal markets? Do you think there is a case for new coal-fired generation in the U.S. at some point in the near to mid-future?

That's ultimately a question that utilities will have to answer in the next several years. Our company produces just over 5 million tons of Central Appalachia thermal coal per year that we sell primarily to southeastern utilities.

From a Central Appalachian perspective, anybody who can burn other basins or burn natural gas is doing so. As a result, our company, like most companies in the region, is not focusing their capital investment on their thermal assets but rather on their higher-margin metallurgical coal assets. As that happens and thermal reserves are depleted without reinvestment, it really calls into question the adequacy of the thermal coal supply that will exist in Central Appalachia in the near term.

It will be interesting to see, if burns maintain like they have through the beginning of this year, where buyers will go to find Central Appalachia thermal coal given the limited availability and the limited number of producers that are still active in that market.

What do you think are some of the major lessons the industry has learned from its recent rough period?

I'd say first of all, not to do leveraged transactions.

Obviously, most of the restructuring that occurred in 2014 through 2016 all resulted from highly leveraged M&A around the earlier part of the decade. Talking just a metallurgical coal context, given the volatility we've seen in our pricing and the evolution of how that product prices with more reliance than ever on daily spot prices, the only thing that a coal producer can do is maintain a focus on their operating cost and try to put their capital structure in place to be able to withstand that volatility.

With that said, you look around at the folks that made it through this difficult spell, you'll notice a common theme in that all these companies are owner/operator-controlled companies where the principal is often one of the primary owners. Those folks have shown a willingness to continue on without forcing the restructuring and continuing to push forward.

Now, the challenge will be for these owner/operators, including ourselves, to continue to delever given the coal markets we see in front of us.

You mentioned there was a need for supply rationalization in the coal sector in 2015. How far off are we from seeing coal supply rationalized with coal demand and what will it take to get there?

Since 2015 you've definitely seen that in Central Appalachia. You've definitely seen that within the metallurgical segment in the U.S.

If anything you've seen a rationalization and a splitting of the metallurgical coal production base. What used to be one or two producers producing most [metallurgical coal], we now have about five producers all producing about the same amount of metallurgical coal in the U.S.

Blackhawk is a totally different company than what we were in 2015, when we were very active in the Illinois Basin. We no longer have any production in that basin at present. It's an area where a lot of oversupply still lingers. But from a supply and demand perspective, it does feel that domestic metallurgical picture is pretty healthy given a lot of the rationalization that happened in 2015 and 2016.