Fitch Ratings on Oct. 27 said that, after the failure of Arch Coal (NYSE: ACI) to complete debt exchange offers that would have relieved the company’s debt crisis, said that bankruptcy for this major coal producer is now more likely.
Fitch has downgraded some of Arch Coal’s debt. “The downgrade reflects Fitch’s view that a bankruptcy is more likely following the expiration of the exchange offers without executing a distressed debt exchange,” said Fitch. “Fitch believes Arch’s current capital structure is unsustainable and that restructuring is necessary. Failure to execute a restructuring outside of court would likely result in bankruptcy.”
Fitch is assuming a fairly slow recovery even though the coal price slide began in earnest in 2012. As such, Fitch 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%.
A substantial portion of domestic coal production is in restructuring, Fitch noted. Alpha Natural Resources and Walter Energy are currently trying to reorganize in bankruptcy. James River Coal and Patriot Coal have had their assets auctioned off in bankruptcy. Together, these companies 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 for 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 pointed out.
On the bright side, in contrast to other restructuring companies, Arch benefits from relatively low exposure to employee legacy liabilities and as of Dec. 31, 2015, only six of its 5,000 employees belong to a union, Fitch said. Basically, Patriot Coal took on pretty much all of Arch’s union liabilities a few years ago in an asset sale deal. 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, said Fitch. Lack of new coal-fired power plant builds and the shuttering of obsolete plants is expected to result in a 10%-15% decline in coal production over the medium term. The U.S. steel industry is currently suffering from import competition which weighs on domestic metallurgical (met) coal consumption.
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, said Fitch. In particular, Fitch believes the hard coking coal bench mark price could average about $95/tonne (t) 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. U.S. exports, which peaked at 125 million tons in 2011, are challenged by rail transport to port and the strong U.S. dollar. Fitch expects U.S. exports to drop back into the 50 million ton range over the medium term.
Arch Coal benefits from large, well-diversified operations and good control of low-cost production, said Fitch. Globally, Arch is the sixth largest coal producer based on volumes. The company sold 134 million tons 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 U.S. at 5.1 billion tons.
Cash burn for Arch Coal is expected to continue absent substantial recovery in met coal prices, said Fitch. Under the current capital structure, guidance for cash interest expense is $360 million to $370 million and for capital expenditure is $130 million to $140 million for 2015. Fitch expects cash burn of at least $200 million per year through 2017.