Coal news and updates

Arch Coal shares could fall to 75 cents

We are assigning Underperform rating and a one-year price target of 75 cents to shares of Arch Coal and a Sell rating to the term loan.

We are lowering our ratings to Sell from Buy on the 7.00% senior notes due 2019 and the 7.25% notes due 2020 to Sell and are maintaining our Buy ratings on the other Arch (ticker: ACI) senior notes and the 8.00% second-lien notes.

The fundamental story at Arch has not significantly changed since the second quarter, in our view -- a large domestic thermal-coal business and aggressive cost-cutting (including the ramp-up of the low-cost Leer mine) has reduced the downside volatility in the face of a very weak export market. Arch has a large $1.3 billion liquidity cushion and no material debt maturities prior to the 2018 term loan maturity. Management expects free cash burn below $200 million in 2014 and 2015, Powder River Basin ( PRB ) pricing and volumes are trending higher, while the metallurgical-coal business is stabilizing albeit at very low levels.

Arch’s capital structure was hit hard following the coldest summer in coal-consuming regions in 30 years, deteriorating conditions in seaborne met coal, and a general flight by investors from the sector.

Arch’s senior note maturities cannot be refinanced unless met-coal prices move back above $170 a ton, a prospect that looks unlikely, and therefore restructuring on or before the May 16, 2018, term-loan maturity seems likely, an event that could severely impact the value of existing equity. We therefore have to estimate recoveries based on assumptions for normalized coking coal that would prevail at the time of filing. At current pricing ($120 a ton), value stops at the first or second-lien tranches; at $140 a ton, value could stop at the senior notes, at prices above that, the senior notes become interesting.

While the internal rates of return (IRRs) to a filing for the senior notes are negative at current pricing, IRRs surpass 10% when normalized coking coal is at $140 a ton or above. We prefer the senior parts of the capital structure -- specifically the second liens, and otherwise would focus on low-dollar priced, high-coupon unsecured notes that have a high-IRR to a potential recovery of 30. Using normalized earnings before interest, taxes, depreciation and amortization (Ebitda) of $440 million at $140 a ton, and applying a 7.0 times multiple, the senior notes could recover 30; IRRs to an estimated recovery of 30 are 12.8% for the 9.875% notes and the 7.25% notes of 2021. While the term loan is covered in most scenarios, IRRs of 10% are not interesting given tranche leverage above 6.0 times, we would be more constructive if the term loan were to trade down to the low-80s. We also note the risks, albeit remote, that the company expands its first-lien capacity.

Source: online.barrons.com