Arch on the brink

FITCH Ratings has downgraded Arch Coal’s senior secured revolving credit facility and its senior secured term loan from “CCC-/RR2” to “CCC-/RR2” as a substantial portion of US domestic coal production is already in restructuring.

Lou Caruana

Alpha Natural Resources, Walter Energy, James River Coal Company, and Patriot Coal Corporation, together, accounted for about 13% of U.S. coal production in 2013 and Arch accounted for an additional 13%.

“Recently, coal assets have changed hands at very distressed values comprising little or no cash given the need to invest in capital and fund reclamation expenditures as well as legacy pension and other postretirement liabilities,” Fitch said.

Fitch's analysis of Arch is based on a going concern enterprise value of nearly $US2.2 billion derived from a $400 million EBITDA and a 5.5x multiple.

Fitch assumes administrative claims will be 10% and that concessions will be 5% of the enterprise value. Under this valuation, the first lien senior secured debt, including an estimate of $122.8 million drawn under the $250 million revolver, has superior recovery given default at 89%.

Fitch is assuming a fairly slow recovery even though the coal price slide began in earnest in 2012.

It does not forecast EBITDA to reach $400 million through 2017 but believes $400 million reflects a conservative long-term estimate. At an EBITDA assumption of $330 million, the senior secured debt has a superior recovery at 73%.

In contrast to other restructuring companies, Arch benefits from relatively low exposure to employee legacy liabilities and as of December 31, 2015, only six of its 5,000 employees belong to a union. Self-bonding of $458.5 million, $177.7 million surety bonds, and $3.5 million in secured letters of credit support reclamation obligations as of Dec. 31, 2014. These would need to be assumed or replaced in the event of asset sales or an acquisition.

Steam coal demand in the U.S. is currently suffering from heavy competition from very low natural gas prices, supply has been disciplined, but stocks are on the high side and prices are soft, according to Fitch.

“Lack of new coal fired power plant builds and shuttering obsolete plants is expected to result in a 10-15% decline in coal production over the medium term. The US steel industry is currently suffering from import competition which weighs on domestic metallurgical (met) coal consumption,” Fitch said.

“Globally, both met and steam coal markets are in excess supply and prices are weak. Coal producers have been running for cash with a focus on reducing costs which has delayed price recovery.”

In particular, Fitch believes the hard coking coal bench mark price could average about $95/tonne and the Newcastle steam coal benchmark could be below $60/t over the next 12 months versus current prices of $89/t and $67.80/t respectively. US exports, which peaked at 125 million tons in 2011, are challenged by rail transport to port and the strong U.S. dollar.

Fitch expects US exports to drop back into the 50Mt range over the medium term.

Globally, Arch is the sixth largest coal producer based on volumes. The company sold 134Mt of coal in 2014. As of June 30, 2015, roughly 97% of expected 2015 steam coal production volumes are committed and priced.

Assuming no change in sales volume for 2016, about 47% of steam tons are committed and priced. The company has the third largest coal reserve position in the US at 5.1Bt.