TEXT-S&P cuts Alpha Natural Resources Inc rating to 'B+'
Overview -- U.S.-based Alpha Natural Resources Inc. is cutting production amid a sharp cyclical drop in domestic demand for coal, which will lead to lower-than-expected EBITDA in 2012 and 2013. -- We are lowering our ratings on Alpha Natural Resources, including the corporate credit rating, to 'B+' from 'BB-', and are removing all of the ratings from CreditWatch, where we placed them with negative implications on Sept. 19, 2012. -- We assigned our 'B+' issue-level rating and '3' recovery rating to the company's proposed $500 million senior unsecured notes. -- Our stable rating outlook reflects our view that although leverage metrics will remain outside of our rating expectations for the next year to two years, the company's liquidity is strong to weather the downturn. Rating Action On Sept. 27, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Bristol, Va.-based Alpha Natural Resources Inc. to 'B+' from 'BB-'. The rating outlook is stable. We also lowered our issue-level rating on Alpha's $1.5 billion senior notes due 2019 and 2021 to 'B+' from 'BB-', while maintaining the '3' recovery ratings on these notes, which indicate our expectation for meaningful (50% to 70%) recovery in the event of default. We also lowered the issue-level rating on subsidiary Massey Energy Co.'s 3.25% convertible senior notes due 2015 to 'B+' from 'BB-', and maintained the recovery rating at '4', which indicates our expectation for an average (30% to 50%) recovery in the event of default. In addition, we lowered our issue-level rating on Alpha's 2.375% convertible notes due 2015 to 'B-' from 'B'. The recovery rating on those notes remains '6', indicating our expectation for a negligible (0% to 10%) recovery in the event of default. We also removed all ratings from CreditWatch, where we placed them with negative implications on Sept. 19, 2012. Concurrently, we assigned our 'B+' (the same as the corporate credit rating) issue-level rating and '3' recovery rating to Alpha's proposed $500 million senior unsecured notes due 2020. The '3' recovery rating indicates our expectation for a meaningful (50% to 70%) recovery in the event of payment default. We expect the company to use proceeds from the proposed notes to partially tender for Massey Energy's 3.25% convertible senior notes due 2015, for related fees and expenses, and to add cash to the balance sheet. Rationale The downgrade reflects our expectation that Alpha's 2012 and 2013 EBITDA will be much lower than previously anticipated because of a sharp cyclical downturn in domestic coal demand. We believe that a warmer-than-normal winter and natural gas substitution accelerated what we view as a sustained decline in the economic viability of thermal coal produced in the Central Appalachia (CAPP) basin, which presently accounts for about 40% of Alpha's production. In addition, fewer production disruptions and slowing demand in China and the Eurozone have caused metallurgical (met) coal prices to decline, further pressuring performance. As a result, Alpha recently cut its 2012 and 2013 production guidance, stating it will reduce annualized coal production and shipments by approximately 16 million tons. Our baseline scenario assumes that Alpha produces about 100 million tons in 2012, down from our previous expectation of about 110 million tons. In 2013, we estimate production of between 80 million tons and 85 million tons, down from our previous expectation of 90 million tons. Alpha plans to curtail production in its high-cost thermal mines, predominantly in CAPP, and to a lesser degree in the Powder River Basin in southeast Montana and northeast Wyoming, thus boosting its exposure to the volatile met coal market. We estimate the company will generate between $600 million and $700 million in EBITDA in 2012 and $500 million and $600 million in EBITDA in 2013, as we expect both thermal and met coal prices to remain weak through 2013. This implies a leverage range of between 6x and 8x in 2012 and 2013, well above our 5x threshold for the previous rating. We also expect funds from operations (FFO) to drop below 10%. Although we expect 2012 and 2013 debt ratios to be weak for the 'B+' rating, we believe the current downturn in the coal sector is primarily cyclical rather than secular, and we expect ratios to return to levels more consistent with our "aggressive" financial risk profile over the next several years. In addition, the company's strong liquidity position, which we estimate exceeds $1.5 billion in balance sheet cash and revolver availability, provides support for the rating at current levels. However, the company's exposure to the high-cost CAPP basin, which we believe--even with production cuts--will likely still account for at least 50% of the company's total production, led us to revise our view of the company's business risk profile to "weak" from "fair." Our corporate credit rating on Alpha reflects what we consider to be the company's "weak" business risk and its "aggressive" financial risk profiles. Risks include meaningful operations in 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 and the company's significant reserve base. Alpha is the nation'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 We view Alpha's liquidity position as "strong" based on the following expectations: -- Liquidity sources (including cash and availability under the company's $1 billion revolving credit facility) will exceed uses by at least 1.5x over the next year; -- Liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30%; and -- The company would continue to exceed the availability threshold under its credit facility, even if EBITDA drops by 30%. Pro forma for the proposed refinancing, we expect Alpha to have between $500 million and $600 million of cash on its balance sheet by year-end 2012. In addition, the company has a $1 billion undrawn revolving credit facility due 2016 and a $254 million accounts receivables securitization facility due 2014, which has approximately $90 million of capacity after accounting for letters of credit. We project FFO of between $350 million and $400 million in 2012 and 2013. We expect free operating cash flow to be neutral, as we would expect the company to match capital expenditures to cash flow generation while the coal markets remain weak. In June, the company amended the covenants that govern its $1 billion revolving credit facility. The revolver is subject to a minimum interest coverage ratio requirement of 2.5x, which steps down to 2.25x in the fourth quarter of 2012. It is also subject to a net senior secured leverage ratio of 2.5x, as well as a minimum total liquidity covenant of $500 million. We expect Alpha will maintain at least a 30% cushion in its compliance with these covenants over the next few quarters. The nearest maturities for Alpha include the 3.25% Massey convertible notes and 2.375% Alpha convertible notes, which are both due in 2015. Recovery analysis For our most recent recovery analysis, please see the recovery report on Alpha, to be published on RatingsDirect shortly following the release of this report. Outlook The stable rating outlook reflects our view that although leverage metrics will remain outside of our rating expectations for the next year to two years, with debt-to-EBITDA of between 6x and 8x, and FFO-to-debt of less than 10%, we believe the current downturn in coal is cyclical rather than secular. In addition, we believe Alpha's liquidity is strong to weather the current downturn. We would lower our rating if the operating environment worsens from current levels, leading the company to burn cash, such that we no longer deemed liquidity to be strong. This could occur if total liquidity fell to less than $1 billion. Though an upgrade seems unlikely in the near term given the current operating environment, one could occur over time if domestic coal demand improves and exports increase such that the company maintains leverage between 3x and 4x. Related Criteria And Research -- Issuer Ranking: North American Metals And Mining Companies, Strongest To Weakest, July 10, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Lowered; CreditWatch Actions To From Alpha Natural Resources Inc. Corporate Credit Rating B+/Stable/-- BB-/Watch Neg/-- Senior Unsecured B+ BB-/Watch Neg Recovery Rating 3 3 Conv sr nts B- B/Watch Neg Recovery Rating 6 6 Massey Energy Co. Senior Unsecured B+ BB-/Watch Neg Recovery Rating 4 4 New Rating Alpha Natural Resources Inc. Senior Unsecured US$500 mil nts due 12/31/2020 B+ Recovery Rating 3