TEXT-S&P cuts James River Coal to 'CCC+'
Overview -- We expect U.S.-based James River Coal Co.'s revenues and EBITDA in 2012 and 2013 will likely be lower than our previous expectation because of a warmer-than-normal winter and ongoing natural gas substitution. -- We are lowering our corporate credit rating on James River Coal to 'CCC+' from 'B-' and are also lowering our issue ratings. -- We are removing all ratings from CreditWatch, where we placed them with negative implications on Feb. 29, 2012. -- The negative outlook reflects our view that the current market conditions, including a rapid decline in demand for coal, will continue to hurt the company's near-term operating performance. Rating Action On June 25, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Richmond, Va.-based James River Coal Co. to 'CCC+' from 'B-'. We are removing the ratings from CreditWatch, where we placed them with negative implications on Feb. 29, 2012. The outlook is negative. At the same time, we lowered our issue rating on the company's $275 million senior unsecured notes to 'B-' from 'B'. The recovery rating remains '2', indicating our expectation for a substantial (70% to 90%) recovery in the event of payment default. We also lowered our issue rating on the company's convertible notes to 'CCC-' from 'CCC'. The recovery rating on the convertible notes remains '6', indicating our expectation for a negligible (0% to 10%) recovery in the event of payment default. Rationale The downgrade reflects our assessment that market demand for coal has deteriorated such that we expect James River Coal's performance will likely be materially lower than we previously expected. We believe that a warmer-than-normal winter and natural gas substitution have accelerated what we view as a sustained decline in the economic viability of thermal coal produced in the Central Appalachia (CAPP) basin. In addition, fewer production disruptions in Australia and slowing demand in China and the eurozone have caused metallurgical (met) coal prices to decline, further pressuring James River Coal's performance. Based on our expectation that coal markets will be weaker through 2013, we believe that the company's liquidity is likely to deteriorate. As of May 2012, James River Coal had priced 8.6 million tons of CAPP coal at an average price of about $95 per ton and 2.8 million tons of Illinois Basin coal at about $44 per ton in 2012. In addition, the company had sold about 600,000 tons of met coal that it had not yet priced. For 2013, the company has priced 1.3 million tons of CAPP coal at $80 per ton and 2.1 million tons of Illinois Basin coal at $45 per ton. Thermal coal production costs in CAPP are about $70 to $80 per ton, which we believe are the highest in the region. As a result, our base case scenario anticipates that James River Coal will generate about $100 million in adjusted EBITDA in 2012, lower than the $170 million in EBITDA the company generated in 2011, because of lower prices and higher costs. As a result, debt to EBITDA is likely to be 7x or higher by year end, and the company is likely to burn cash. For 2013, Standard & Poor's believes that high coal inventories and low natural gas prices are likely to keep coal prices weak. In addition, export prices for met coal are unlikely to be high enough to offset domestic weakness, and port capacity is limited. Although met-coal markets have improved since the first quarter, weak global steel demand will likely keep prices from increasing significantly. Given that James River has contracted a very small amount of tonnage in 2013, EBITDA and liquidity are likely to decline further from 2012 levels. The corporate credit rating on James River Coal reflects what Standard & Poor's considers to be the combination of the company's "highly leveraged" financial risk and "vulnerable" business risk, characterized by the company's small size, high operating costs, capital-intensive operations, and exposure to cyclical end markets. In addition, James River Coal faces the challenges of operating in the CAPP region, which is becoming increasingly expensive and difficult to mine because of mature, thinning seams; escalating costs; and stringent permitting and safety regulations. Coal demand is highly cyclical. With increased competition from natural gas because of its greater supply, the swings in demand as a result of the economy can be more significant than has historically been the case. We remain concerned that CAPP coal producers will continue to lose market share to the Powder River Basin and Northern Appalachian coal-producing regions during the next several years as output from the CAPP region continues to shrink because of difficult operating conditions. Liquidity Given our operating expectations, we now view James River Coal's liquidity as "less than adequate." Our view of the company's liquidity profile includes expectations that: -- Liquidity sources (including cash and availability under the company's $100 million revolving credit facility) will exceed uses by at least 1.2x over the next year and at least 1.0x over the next 18 to 24 months. -- The company likely would not be able to absorb high-impact, low probability events. The company's total liquidity on March 31, 2012, was $208.5 million, consisting of $169.4 million of cash and $39.1 million of availability under the company's revolving credit facility. In 2012, we expect the company to burn between $40 million and $50 million of cash, as we don't believe cash flows from operations will be enough to cover capital expenditures. In 2013, barring an improvement in shipments and pricing, which at this point we do not anticipate, we expect the cash burn to increase. James River Coal's revolving credit facility is governed by a maximum capital expenditures covenant and a minimum fixed charge covenant, which are based on total liquidity. Although we expect the company to maintain adequate headroom under these covenants in 2012, we believe headroom could tighten in 2013 as we think the company's liquidity is likely to deteriorate. James River Coal does not have any significant maturities until 2015, when its revolving credit facility and 4.5% convertible notes mature. Recovery analysis For the complete recovery analysis, please see the recovery report on James River Coal, to be published on RatingsDirect shortly following the release of this report. Outlook The negative rating outlook reflects our view that although the company's liquidity is likely to remain sufficient to cover its financial obligations over the near term, liquidity could become strained barring an improvement in shipments and pricing in 2013. It also takes into account the extremely difficult operating environment for James River Coal as a relatively high cost producer in the CAPP basin and our expectations the company will burn cash and post debt to EBITDA of 7x or higher. We could lower our rating if the company's liquidity deteriorates, such that cash burn accelerates, and the cushion narrows on the covenants that govern its credit facility. This could occur if coal pricing remains weak into 2013. A positive rating action is unlikely in the near term, given the challenging operating conditions and weak demand for coal. However, one could occur if market demand and pricing gained significant positive momentum such that James River Coal would be able to significantly increase its production, secure long-term contracts at economic prices for its coal, and improve its liquidity. Related Criteria And Research -- Issuer Ranking: North American Metals And Mining Companies, Strongest To Weakest, April 13, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Metals Industry, June 22, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; Removed From CreditWatch To From James River Coal Co. Corporate Credit Rating CCC+/Negative/-- B-/Watch Neg/-- Senior Unsecured CCC- CCC/Watch Neg Recovery Rating 6 6 James River Escrow Inc. Senior Unsecured B- B/Watch Neg Recovery Rating 2 2