TEXT-S&P raises Westmoreland Coal rating to 'B-'
Overview -- U.S.-based Westmoreland Coal Co.'s liquidity has improved after it negotiated less restrictive covenants for a term loan and obtained a new asset-backed revolving credit facility. -- We are raising our ratings on Westmoreland, including the corporate credit rating and issue-level rating, to 'B-' from 'CCC+'. -- The stable rating outlook reflects our view that Westmoreland will maintain an EBITDA cushion of at least 15% over its revised covenants for the next year or so. Rating Action As previously announced, on Nov. 1, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Englewood, Co.-based Westmoreland Coal Co. (WLB). to 'B-' from 'CCC+'. The rating outlook is stable. At the same time, we raised the issue-level rating on WLB's $275 million senior secured notes due 2018 to 'B-' (the same as the corporate credit rating) from 'CCC+'. The recovery rating remains a '4', reflecting our expectation for average (30%-50%) recovery for lenders under our default scenario. Rationale The upgrade reflects our view that WLB is less vulnerable to default after successfully negotiating less restrictive covenant requirements for an unrated $110 million term loan due 2018. Our assessment of WLB's business risk profile as "vulnerable" and financial risk profile as "highly leveraged" are unchanged. We are revising our liquidity score to "adequate" based on the covenant relief and additional liquidity provided under the company's new $20 million asset-based loan (ABL) facility from "less than adequate." Our outlook for the coal industry remains negative because demand for domestic coal is still depressed due to natural gas substitution and continued high inventories at utilities following last year's unusually warm winter. Our base-case scenario anticipates that WLB will produce around 22 million tons of coal in 2012 and generate EBITDA (including adjustments for pension and asset retirement expenses) of about $135 million. This EBITDA figure is higher than our earlier projections due to better-than-expected performance from the company's recently acquired Kemmerer mine, which boasts higher margins than its other mines. At year-end, we expect the company's total debt to approximate $800 million, including $440 million in adjustments for pensions, asset retirement obligations, and operating leases. We expect leverage at year end to be around 5.9x, with funds from operations (FFO)-to-debt of about 8%. In 2013, we expect EBITDA will grow modestly to about $145 million, and that debt reductions in the form of required amortization and excess cash flow payments will reduce total debt by about $30 million. These factors lead us to anticipate further improvements in credit metrics by the end of 2013, with leverage around 5.3x and FFO-to-debt of about 10%. WLB operates six coal mines in Montana, Texas, North Dakota, and Wyoming, with 80% of its coal reserves concentrated in the Powder River Basin (PRB). The company has about 486 million tons of proven or probable coal reserves, a significant increase over the past several years, and it estimates that its proven and probable reserves will last 10 to 40 years. We believe that WLB, which has about 80% of capacity in the northern PRB, is a high-cost coal producer. Despite the company's strategy of operating mines situated at or near its electric utility customers, thus reducing transportation costs, we estimate that it operates at cash costs well above $10 per ton--significantly higher than those of its larger competitors in the region. The company also has significant customer concentration. In 2012, we expect it will generate approximately 65% of total revenues from coal sales to five power plants, leading to the risk that any mine disruptions or unexpected customer outages could hurt profitability. However, nearly all of WLB's production is sold under long-term contracts and provides for sales to customers for periods of three to nine years. In our view, these contracts somewhat limit customers' ability to switch suppliers before their contracts expire and provides some predictability to the company's revenue stream. WLB also operates two coal-fired power-generating units with a total capacity of 230 megawatts in North Carolina. The company conducts its power operations through its subsidiaries (collectively, ROVA). It purchases coal for ROVA under long-term contracts from suppliers in Central Appalachia. The ROVA facilities supply electricity to Dominion Virginia Power under power purchase agreements extending through 2019 and 2020. However, ROVA's coal supply agreements extend through 2014 and 2015 at prices substantially below current market rates. Dominion is not obligated under the fixed-price purchase power agreement to bear potentially significantly higher fuel costs. As a result, WLB's ROVA facilities could incur substantial operating losses starting in 2014. Although outside of the rating time horizon, we have assumed a significant decline in revenue from the ROVA facilities in 2015, no further revenue contributions in 2016, and a $50 million charge in 2016 to account for any associated losses. Liquidity We regard WLB's liquidity as adequate, based on the following assumptions: -- Liquidity sources, which primarily consist of FFO generation and availability under the ABL facilities, will exceed uses by at least 1.2x over the next 12-18 months; -- Liquidity sources will continue to exceed uses, even if EBITDA were to decline by 15%; and -- Compliance with assumed financial maintenance covenants would likely survive a 15% drop in EBITDA. As of Sept. 30, 2012, WLB had total liquidity of $97 million, consisting of $54 million in cash and $43 million in total availability under its $20 million ABL at WLB due 2017 and its $25 million ABL at its subsidiary Westmoreland Mining LLC (WML) due 2013. The company recently amended covenant measures under its WML subsidiary $110 million term loan due 2018 (unrated). WML's required leverage ratio will now step down to 1.5x from the current 2.25x in quarterly increments over the course of 2013, a more gradual change than the previous requirement to step down to 1.5x as of year-end 2012. We expect that WLB will be able to maintain at least a 15% EBITDA cushion under the new covenant restrictions. We anticipate that WLB will generate cash flow from operations of around $59 million in 2012, which will cover its expected capital expenditures of $26 million. We project the company will end the year with about $44 million in cash, some of which will be used to reduce debt under the company's required 75% excess cash flow sweep. In 2013, we expect the company to produce free operating cash flow in the range of $50 million to $55 million, after capital spending of about $20 million. WLB's debt maturities over the next several years are manageable. Its notes and term loan debt are due in 2018. The company has not paid dividends on its common stock for some time, and we don't anticipate it will pay any common stock dividends in the foreseeable future. Recovery analysis We rate WLB's $275 million term loan 'B-' (same as the corporate credit rating) with a recovery rating of '4', indicating our expectation of average (30%-50%) recovery for bondholders in the event of a payment default under our default scenario. Standard & Poor's does not rate WML's term loan. Outlook The stable rating outlook reflects our expectation that, despite headwinds in the coal industry, WLB will maintain a minimum 15% EBITDA covenant cushion over the next 12 to 18 months while continuing to improve its credit metrics. A positive rating action is unlikely given the company's highly leveraged financial profile (we expect debt-to-EBITDA of around 6x in 2012) and vulnerable business profile. We could raise the ratings if we expect the company to maintain leverage metrics below 5x and FFO-to-debt above 12%. This could occur if the company increases its mine diversity and production levels without adding to its existing debt load. We would consider a negative rating action if, as a result of deterioration in operating performance during the next several quarters, WLB's credit measures and liquidity position deteriorated. This could include the financial covenant cushion falling below our 15% EBITDA benchmark. This could occur if the economic recovery takes longer than we expect, if the company incurs greater-than-expected costs in association with its ROVA contracts, or if coal-powered electricity consumption falls, resulting in a decline in total coal volumes sold. Related Criteria And Research -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Raised; Outlook Stable To From Westmoreland Coal Co. Corporate Credit Rating B-/Stable/-- CCC+/Positive/-- Senior Unsecured B- CCC+ Recovery Rating 4 4