Fitch Ratings said July 27 that it has downgraded the Issuer Default Rating (IDR) to ‘CCC’ from ‘B’ for Peabody Energy (NYSE: BTU), which is the largest U.S. coal producer and a major producer of metallurgical coal in Australia.
Approximately $8.4 billion in face amount of debt and commitments is affected by these rating actions. The downgrade reflects Fitch’s view that liquidity could become constrained in the absence of higher metallurgical coal prices. For 2015, Fitch believes EBITDA could be about $400 million and free cash flow burn could reach about $500 million.
While Fitch said it believes the cash burn would slow in 2016 and reverse in 2017 with the roll-off of hedges, halt of lease by application (LBA) and Voluntary Employee Beneficiary Association (VEBA) payments and modest recovery in metallurgical coal prices, the total debt with equity credit to EBITDA could be above 7x in 2017, which could limit access to capital to refinance the $1.5 billion notes due 2018. Fitch believes the coal markets are at or near the bottom of the cycle and should show slow recovery but that excess capacity has been slow to rationalize.
Peabody Energy’s credit ratings reflect large, well-diversified operations, good control of low-cost production, exposure to high growth markets in Asia, top-line visibility in the domestic market, adequate 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 Australia’s Macarthur Coal Ltd., has resulted in low earnings, cash flows and debt repayment.
“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,” wrote Fitch. “Lack of new coal fired power plant builds and shuttering obsolete plants constrains growth in the U.S. Globally, both metallurgical (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 $105/tonne (t) and the Newcastle steam coal benchmark could be below $62/t over the next 12 months versus current prices of $93/t and $67.80/t respectively. The industry is consolidating, which should benefit supply/demand dynamics longer term.”
It added about Peabody: “Fitch believes operating EBITDA could drop to $400 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 about $500 million. Peabody guides to 2015 capital expenditure of $170 million to $190 million before coal lease expenditures ($280 million in 2015). Cash interest expense runs about $430 million and dividends are about $3 million, annually. Management believes the 2014 capital spending level can be maintained for two to three years.”
Key assumptions for Fitch are:
- 2016 Benchmark hard coking coal and Newcastle prices of $105/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; and
- No additional asset sales are factored into the projections.
Peabody is the largest private sector coal company, globally, with 26 active mining operations producing primarily low-sulfur thermal coal from the Powder River Basin (2014, 142 million tons sold), high heat thermal coal from the Illinois Basin (2014, 25 million tons sold), and thermal and metallurgical (met) coal in Australia primarily for the Pacific Basin seaborne markets (2014, met 18 million tons sold, steam 20 million tons sold).