TEXT - S&P raises James River Coal Inc to 'CCC'
Overview -- U.S.-based coal producer James River Coal Co. repurchased $61 million of its debt at a discount but remains highly leveraged in our view. -- We have raised our corporate credit rating on the company to 'CCC' from 'SD' (selective default). -- We have also raised our rating on the company's 7.875% senior notes due 2019 to 'CCC+' from 'D' and raised the rating on the company's 4.5% and 3.125% convertible notes to 'CC' from 'D'. -- 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 Nov. 15, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Richmond, Va.-based James River Coal Co. to 'CCC' from 'SD' (selective default). The outlook is negative. At the same time, we raised our issue rating on the company's 7.875% senior notes due 2019 to 'CCC+' (one notch above the corporate credit rating) from 'D'. The recovery rating on these notes remains '2', indicating our expectation for substantial (70%-90%) recovery in the event of payment default. We also raised our issue-level rating on the company's 4.5% and 3.125% convertible notes to 'CC' (two notches below the corporate credit rating) from 'D'. The recovery rating on these notes remains '6', indicating our expectation for negligible (0%-10%) recovery in the event of payment default. Rationale We raised our rating on James River Coal because we understand that the company has stopped repurchasing its debt at deep discounts, for the time being. On Nov. 7, we lowered our corporate credit rating on James River to 'SD' and lowered our rating on the company's notes to 'D' because we considered the discounted repurchase of $61 million of debt (at approximately 60% of face value) to be tantamount to default under our criteria for exchange offers and similar restructurings. Still, we view the company's debt burden to be unsustainable in the long term, and we recognize the potential for additional distressed exchanges or redemptions in the next 12 months. 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 debt burden, and "less-than-adequate" liquidity. In addition, James River Coal faces the challenges of operating in the Central Appalachian (CAPP) region, which is becoming increasingly expensive and difficult to mine because of mature, thinning seams; escalating costs; and stringent permitting and safety regulations. As of November 2012, the company has priced 3.4 million tons of its 2013 CAPP coal tonnage at an average price of about $74 per ton and 2.3 million tons of its 2013 Midwest coal tonnage at an average price of about $45 per ton. In addition, the company had sold about 1.1 million tons of its 2013 metallurgical (met) coal tonnage that it had not yet priced. Thermal coal production costs in CAPP are about $70 to $80 per ton, which we believe are among the highest in the region. 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 around 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 will likely 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. In addition, weak global steel demand will likely keep prices from increasing significantly. Given that James River Coal has contracted a very small amount of tonnage in 2013, EBITDA and liquidity will likely decline from 2012 levels. 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 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; -- We believe the company could face covenant pressure in 2013 if shipments and pricing don't improve; and -- We don't believe the company would be able to absorb high-impact, low probability events. The company had total liquidity of $171.7 million on Sept. 30, 2012, consisting of $151.4 million of cash and $20.3 million of borrowing capacity under the company's revolving credit facility. In 2012, we expect the company to burn between $25 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 company to use more cash than in 2012. James River Coal's revolving credit facility is governed by a maximum capital expenditures covenant, which is triggered when total liquidity falls below $50 million, and a minimum fixed-charge covenant, which is triggered when total liquidity falls below $35 million. Although we expect the company to maintain adequate headroom under these covenants in 2012, we believe headroom could tighten in 2013 because we think the company's liquidity is likely to deteriorate. James River Coal does not have any significant maturities until 2015, which is when its revolving credit facility and 4.5% convertible notes mature. Recovery analysis The issue-level rating on James River Coal's 7.875% senior notes is 'CCC+' (one notch above the corporate credit rating), with a recovery rating of '2', indicating our expectation for substantial (70% to 90%) recovery in the event of payment default. The issue-level rating on the company's 4.5% and 3.125% convertible notes is 'CC' (two notches below the corporate credit rating), with a recovery rating of '6', indicating our expectation for negligible (0% to 10%) recovery in the event of payment default. Outlook The negative 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 in 2012 and 2013. 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 could significantly increase its production, secure long-term contracts at economic prices for its coal, and improve its liquidity. Temporary telephone contact numbers: Megan Johnston (917-715-3892); Gayle Bowerman (540-270-3708). Related Criteria And Research -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In the Mining Industry, June 23, 2009 -- Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded; Outlook Action To From James River Coal Co. Corporate Credit Rating CCC/Negative/-- SD/--/-- Senior Unsecured CC D Recovery Rating 6 6 James River Escrow Inc. Senior Unsecured CCC+ D Recovery Rating 2 2
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