Fitch Ratings said March 2 that it has downgraded coal producer Peabody Energy‘s (NYSE: BTU) Issuer Default Rating (IDR) and senior unsecured notes to ‘B’ from ‘BB-‘, and assigned a ‘BB-/RR2’ rating to the proposed $1 billion second lien notes.
Net proceeds of the notes for Peabody, the nation’s largest coal producer, are intended to be used to fund the tender offer for $650 million senior unsecured notes due 2016 and for general corporate purposes. Approximately $7.3 billion in face amount of debt, including the $650 million of notes tendered for, is affected by these rating actions.
The Rating Outlook has been revised to Stable from Negative. Fitch said this is because it believes the coal markets are at or near the bottom of the cycle and should show slow recovery.
Peabody’s credit ratings reflect its large, well-diversified operations, good control of low-cost production, exposure to high-growth markets in Asia, top-line visibility in the domestic market, strong liquidity, and high financial leverage. Weakness in pricing for the company’s Australian coals, partially offset by cost reductions and currency moves, coupled with high interest expense following the 2011 leveraged acquisition of Macarthur Coal Ltd., has resulted in low earnings, cash flows and debt repayment. The downgrade is the result of Fitch’s expectations that leverage could be above 7x through 2016 before declining.
Peabody is the largest global private sector coal company, with 26 active mining operations producing primarily low-sulfur thermal coal from the Powder River Basin in Wyoming (PRB in 2014, 142 million tons sold), high heat thermal coal from the Illinois Basin (Illinois Basin in 2014, 25 million tons sold), and thermal and metallurgical coal in Australia primarily for the Pacific Basin seaborne markets (2014, met 18 million tons sold, steam 20 million tons sold). As of Dec. 31, 2014, proven and probable reserves were 7.6 billion tons, down from 8.3 billion tons at Dec. 31, 2013.
Steam coal demand in the U.S. is recovering, supply has been disciplined, stocks are falling and prices should improve going forward, Fitch said. Growth is constrained by the availability and currently low price of natural gas.
Globally, both the 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, Fitch wrote. In particular, Fitch believes the hard coking coal benchmark price could average below $135/tonne (t) and the Newcastle steam coal benchmark average below $75/t beyond 2015. The industry is consolidating, which should benefit supply/demand dynamics longer term.
Fitch believes operating EBITDA for the St. Louis-based company could drop below $500 million for 2015 on low average metallurgical coal prices and Asia Pacific steam coal prices. Under the same assumptions, negative free cash flows could be as much as $450 million. Peabody guides to 2015 capital expenditure of $180 million to $200 million before coal lease expenditures ($280 million in 2015). Currently, cash interest expense runs about $400 million and dividends are about $3 million, annually. Fitch believes pro forma cash interest expense could be more than $450 million depending on the size of the issue and the interest rate. Management believes the 2014 capital spending level can be maintained through 2016.
The key assumptions for Fitch in its findings are:
- 2015 benchmark hard coking coal and Newcastle prices of $120/t and $65/t, respectively;
- Production in the Western U.S. at 3 million tons below guidance;
- Other production, dividends and capital spending at guidance;
- New debt up to $1 billion;
- 2015 aggregate cash operating cost improvement of 4% over 2014; and
- No asset sale proceeds.