Getting Hot In Here: Coking Coal Edition
Recall that Jet Capital sent a harshly worded letter the SunCoke Energy board last month, arguing that "management's continued lack of any real strategic or capital actions," is to blame for the stock's underperformance. Jet owns about 6.3% stake of SXC and is pushing for capital returns.
The crux of Jet's argument in the original letter is that SXC, since the spin-off of SunCoke Energy Partners as a Master Limited Partnership in 2012, has not fully utilized this advantaged tax structure. In particular, the fund argues that accelerated drop-down of assets from SXC to SXCP would create up to 10% yield for shareholders.
In the most recent letter, Jet alleges that, despite conversations where management assured them they were on the same page, no actions have been taken to increase capital return to shareholders.
"That we have been making this point for months with no real actions or response by management is frustrating," writes Matthew Mark, General Partner at Jet Capital. The sticking point appears to be SXC's reluctance to dropdown assets below its estimate of fair value, whereas SXCP wants to ensure that dropdowns are accretive to its distributions.
Jet Capital has also speculated that SXC may be delaying dropdowns and dividend/buyback increases due to a desire to grow through acquisitions. Management doesn't want to commit to a capital return policy that would constrain its ability to take advantage of acquisition opportunities.
We've talked about SXC being a serial acquirer in the industry, but since then management has shown a marked inability to create growth or shareholder value in recent years. Since the MLP spin-off, the stock is essentially flat, and earnings have largely disappointed. Many other shareholders and analysts expressed agreement with the sentiments in Jet's original letter.
In defense of SXC's management, falling commodity prices have presented a tough macro situation for the stock to excel, and as SXCP's stock price drops, dropdown deals become harder to carry out at a fair price (since SXCP stock is part of the currency used for the deals).
Jet's opinion is that any further delays only reinforce the negative feedback loop, where SXCP's falling stock price makes dropdowns harder to accomplish, which drives the stock down even more.
"Many structuring mechanisms exist that can create mutually beneficial outcomes for both sides," argues Mark, "and the MLP industry is ripe with examples of how to break the feedback loop that now appears to be impeding progress."
Jet Capital ended its letter with the statement "Our patience has been exhausted." This indicates that an attempt to gain board representation may be in the near future. The fund says that either SXC needs to accelerate the pace of dropdowns and boost returns or it needs to sell itself to a buyer that can better take advantage of the MLP structure.
Given its asset base and potential distributable cash flow, SXC's current share price of ~$16.25 is remarkably low. Its paltry 1.18% dividend yield is likely to blame for this low share price. There's no question that SXC could drastically increase its dividend payments if it took Jet's advice and committed to rapidly dropping down assets and distributing the proceeds.
If SXC also cut back on capital spending and decreased G&A by cutting back on growth initiatives, it could easily support a dividend yield of 10% or higher based on its current share price. Analysts at Wells Fargo have estimated the stock could hit $25-$27/share if distributions are increased to this level.
SXC's management needs to accept that it's not a growth business and that the MLP structure is best suited to returning cash to shareholders. Jet Capital has the experience, tenacity, and shareholder support to force this change through. The stock's recent underperformance gives it a very high potential yield for investors.