TEXT-S&P rates Armstrong Energy 'B-'
Overview -- U.S.-based coal miner Armstrong Energy Inc. is seeking to raise $200 million in senior secured notes. -- The company plans to use proceeds from the issuance to reduce indebtedness, as well as for general corporate purposes and for transaction-related fees and expenses. -- We are assigning our 'B-' corporate credit rating to Armstrong and our 'B-' issue-level rating to the company's proposed senior secured notes. The recovery rating on the proposed notes is '4'. -- The rating outlook is stable, reflecting our view that Armstrong's liquidity position and multiyear customer contracts will support credit metrics that are in line with the rating, despite weak coal markets and the company's relatively high capital expenditure requirements. Rating Action On Nov. 29, 2012, Standard & Poor's Ratings Services assigned its 'B-' corporate credit rating to St. Louis, Mo.-based Armstrong Energy Inc. The outlook is stable. At the same time, we assigned our 'B-' issue-level rating (the same as the corporate credit rating) to the company's proposed $200 million senior secured notes due 2019. The recovery rating is '4', indicating our expectation of average (30%-50%) recovery for bondholders in the event of a payment default. The company is offering the notes pursuant to Rule 144a with registration rights. Rationale The corporate credit rating takes into account our view of the company's business risk profile as "vulnerable" and its financial risk profile as "highly leveraged." Armstrong is a pure-play coal producer that generated revenues of about $360 million and EBITDA of about $50 million in the trailing-12-month period ended Sept. 30, 2012. We based our business risk score on our view of the company's participation in the competitive and highly cyclical coal industry. The assessment reflects currently weak industry conditions and the challenges of coal mining, which include price volatility, weather-related disruptions, and increasingly stringent environmental and safety regulations. Although Armstrong enjoys certain logistic and cost advantages from having contiguous mines, having all of its mines in Centerview, Ky., poses concentration risk, in our view. Specifically, the company focuses on one type of coal and relies on a limited number of customers for the bulk of its revenues. We consider Armstrong's financial risk profile to be highly leveraged based on year-end expectations of around 7.5x leverage (adjusted most notably for about $104 million in long term obligations), estimated pro forma interest coverage of 1.5x, and adequate liquidity. Our base-case scenario anticipates that Armstrong will generate revenues of roughly $420 million and $450 million in 2013 and 2014 respectively. This is driven by Armstrong's demonstrated, albeit short, history of growing production from 4.7 million tons in 2009 to an estimated 8.4 million tons for 2012, representing a compound annual growth rate of 22%. However, we expect near-term growth to be much more moderate as the company continues to mature. We assume flat pricing of roughly $45 per ton in 2013, and we project a marginal increase for 2014. We would expect some margin compression as production mix slowly shifts from surface to underground mining, which can be more expensive to produce. We expect the company to generate EBITDA of approximately $50 million and $55 million in 2013 and 2014, respectively. Pro forma for the transaction, we expect Armstrong to have total debt (including adjustments for retirement and other long term obligations) of $345 million, leverage of about 7.5x, and interest coverage of about 1.5x. In our view, Armstrong runs an asset-intensive business, with property, plant and equipment accounting for over 75% of all assets, and the 2013 plan includes capital expenditures in the $25 million range. We anticipate the bulk of cash flow from operations going towards capital expenditures in 2013. Armstrong is a regional distributor of thermal coal with seven contiguous mines in the Illinois Basin. The company was the sixth-largest producer of Illinois Basin coal in fiscal 2011, producing approximately 6% of the total Illinois Basin coal. Armstrong produced 8.1 million tons of coal in the 12 months ending Sept. 30, 2012, and controls 326 million tons of proven and probable reserves. Production has grown steadily as the company continues to focus on its customer base of scrubbed power plants in the Mid-Atlantic, Southeastern, and Midwestern states. Although characterized by the high sulfur content of Illinois Basin coal, Armstrong's coal has comparatively low levels of chlorine, making it less corrosive to electric generation equipment. Yorktown Partners LLC, an energy-only private equity fund with approximately $3.0 billion in assets under management, owns substantially all of Armstrong's outstanding stock and has committed more than $480 million to Armstrong and Illinois Basin investments since 2006. Liquidity Armstrong's liquidity position is "adequate," in our view. Relevant aspects and assumptions in the company's liquidity profile include: -- Liquidity sources, which primarily consist of cash on the balance sheet and availability under the ABL, will exceed uses (largely capital expenditures) 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. Recovery analysis The 'B-' rating on the proposed senior secured $200 million notes is based on preliminary terms and conditions. The recovery rating on the proposed notes is '4', indicating our expectation of average (30%-50%) recovery for bondholders in the event of a payment default under our scenario. The company is selling the notes pursuant to Rule 144a with registration rights. For the complete recovery analysis on Armstrong, see our recovery report to be published on RatingsDirect shortly following the release of this report. Outlook Our stable rating outlook for Armstrong reflects our view that the company's operating performance will support credit metrics that are in line with our expectations for the 'B-' corporate credit rating. We anticipate that Armstrong's products will produce EBITDA in the range of $45 million to $55 million annually over the next 12-24 months, with leverage starting at about 7.5x and unwinding to about 6.5x, and interest coverage rising from approximately 1.5x to 1.7x during that time frame. This view assumes flat pricing for 2013 at roughly $45, with a marginal increase projected for 2014 with tons sold increasing at an average rate of just under 7% over the period. A higher rating is unlikely in the near term, given our view that leverage will likely remain near current levels for some time. This is based on low expected cash flow generation, high capital expenditure requirements, and weak conditions in the coal industry. However, a higher rating would be contingent on decreasing leverage levels below 5x and increasing funds from operations-to-debt above 12% as well as any changes that might mitigate some of the concentration risks associated with the business. We could lower the rating if the company is unable to decrease leverage levels, or if its liquidity position deteriorates such that we view its liquidity to be "less than adequate." This could occur if the company loses a major customer, or has some sort of prolonged disruption in its operations. This could also happen if the company decided to take any capital expenditure or M&A actions that materially decreased net debt levels. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Rating; Outlook Assigned Armstrong Energy Inc. Corporate Credit Rating B-/Stable/-- New Rating Armstrong Energy Inc. Senior Secured US$200 mil sr secd nts due 2019 B- 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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