TEXT-S&P revises Alpha Natural Resources outlook to negative
Overview -- We expect operating conditions for domestic producers of thermal coal and, to a lesser extent, metallurgical coal to be difficult because of a mild winter and natural gas substitution in the U.S. and slower steel production overseas. -- U.S.-based Alpha Natural Resources Inc. is likely to post weaker operating results and credit metrics relative to our previous assumptions. -- We are revising our outlook on Alpha to negative from stable and affirming our ratings, including the 'BB-' corporate credit rating. -- The negative rating outlook acknowledges the potential for a downgrade if leverage climbs above 6x for a sustained period or if Alpha's strong liquidity weakens as a result of further deterioration in market conditions. Rating Action On June 29, 2012, Standard & Poor's Ratings Services affirmed its ratings, including the 'BB-' corporate credit rating, on Alpha Natural Resources Inc. At the same time, we revised the outlook to negative from stable. Rationale The rating affirmation and negative rating outlook reflect our expectations that the domestic steam coal market will remain challenged with the possibility of additional production cuts, while 2013 metallurgical (met) coal prices will likely improve as the global economy improves, benefitting from strong global demand and limited supply. Our corporate credit rating on Alpha reflects what we consider to be the company's "fair" business risk and its "aggressive" financial risk. Risks include meaningful operations in Central Appalachia (CAPP), where coal producers face significant regulatory and environmental constraints, depleting coal seams, rising costs, and high debt. Strengths include the potential for higher met coal prices next year, the company's significant reserve base, and its strong liquidity. Our baseline scenario assumes that Alpha's 2012 production is about 110 million tons, down from our previous expectations of about 118 million tons. Consequently, our expectation for cash costs increases to about $50 per ton from our previous assumptions of about $47 per ton, resulting in EBITDA of below $1 billion. We now estimate debt to EBITDA of about 5x and funds from operations (FFO) to debt of about 17%. We expect 2013 production to decline further to about 90 million tons because of the continuing challenges facing the domestic steam coal market. Although we believe met coal prices will improve, we expect 2013 EBITDA to decline to $750 million to $850 million. Given these assumptions, we expect Alpha's leverage to weaken in 2013 to about 5.5x and FFO to debt of about 15%, levels we believe are still appropriate for our aggressive financial risk profile. It is our opinion that Alpha's large and diverse coal reserves, its position as a leading provider of met coal, and its strong export position will enable the company to benefit from an eventual recovery in coal demand. Alpha is America's third-largest coal producer as measured by production. It is the nation's largest supplier of met coal, which is used in steel-making, and is a major supplier of thermal coal to electric utilities and manufacturing industries. Liquidity In our view, Alpha has "strong" liquidity, based on the following observations and assumptions: -- Liquidity sources (including cash and internally generated cash flow) will exceed uses by more than 1.5x over the next 12 to 18 months; -- Liquidity sources will continue to exceed uses, even if EBITDA were to decline by up to 30%; and -- Alpha's compliance with financial maintenance covenants likely would survive an up to 30% drop in EBITDA without the company breaching covenant test measures. As of March 31, 2012, Alpha has available liquidity of about $1.8 billion, including cash, cash equivalents, and marketable securities of about $700 million and about $1.1 billion in availability under its secured credit facilities. We expect the company to generate free operating cash flow in excess of $300 million in 2012 as lower production results in working capital being a source of cash, in addition to a full year of the Massey operations. We expect capital spending of about $550 million in 2012, comprising both maintenance- and growth-related spending. We also expect cash outflows of about $100 million in 2012, related to the $210 million settlement to resolve the criminal investigation, regulatory civil proceedings, as well as other health, safety, and related issues at Massey. We expect the company to use excess cash to fund growth opportunities, both internally and externally. The company maintains a share repurchase program, which allows it to repurchase up to $600 million of its outstanding common stock. Alpha repurchased about $200 million of its shares in 2011--roughly $100 million of which from this particular program. Alpha does not pay a dividend, and we do not expect Alpha to repurchase any shares under the program in the coming months. Alpha has about $210 million of amortization payments through 2014, with its $287.5 million of convertible notes and $658.7 million of Massey Energy Convertible notes, both due in 2015. The company also expects to make pension plan contributions in 2012 in the $35 million area to achieve at least a 90% funded status with respect to defined benefit retirement plans. The $1 billion senior secured revolving credit facility due 2016 is subject to a minimum interest coverage ratio requirement of 2.5x, which steps down to 2.25x for the fourth quarter of 2012. It is also subject to a senior secured leverage ratio of 2.5x. We expect Alpha will maintain at least a 30% cushion in its compliance with these covenants over the next few quarters. Recovery analysis For the complete recovery analysis, see our recovery report on Alpha, published May 30, 2012, on RatingsDirect. Outlook The negative rating outlook reflects our view that 2013 operating performance could deteriorate more than we expect if the company lowers its production guidance further because of continued weak coal markets, resulting in weaker credit metrics than we currently expect. We could lower our rating if coal demand deteriorates further, if a disruption were to occur at one of its key coal operations, or if costs increase meaningfully, resulting in further production curtailments and weaker credit measures. We would consider a lower rating if debt to EBITDA rose to more than 6x and FFO to total debt fell below 15%, and if these measures were likely to remain for an extended period. We would also consider a downgrade if liquidity, in our view, becomes "adequate," which could occur if Alpha draws more than $600 million against its revolver. Although a positive rating action seems less likely in the near term given the operating environment, one could occur if domestic coal demand improves and exports increase such that leverage strengthened to below 5x and FFO to debt above 15%. Related Criteria And Research -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 Ratings List Ratings Affirmed; Outlook Action To From Alpha Natural Resources Inc. Corporate Credit Rating BB-/Negative/-- BB-/Stable/-- Ratings Affirmed Alpha Natural Resources Inc. Senior Unsecured BB- Recovery Rating 3 Senior Unsecured B Recovery Rating 6 Massey Energy Co. Senior Unsecured BB- Recovery Rating 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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