Let’s not beat around the bush here: The coal sector is in a world of hurt. The dual threats of rising environmental regulation and dwindling demand have crippled many coal stocks over the last few years, and it just keeps getting worse. Profits have cratered, cash flows are nonexistent and bankruptcy has moved from threat to reality for many coal stocks.
The latest victim was metallurgical coal specialist Alpha Natural Resources (ANRZ). Following in the footsteps of Walter Energy (WLT), Alpha Natural finally made it official and bit the dust Monday when it filed for bankruptcy protection.
ANR won’t be the last coal stock to do so, nor should it be. Former industry stalwart Arch Coal (ACI) needs to take the early-filing plunge as soon as possible.
For investors, the potential for another former coal giant to take add to the population of bankrupt coal stocks highlights just how dangerous the sector is getting.
ACI & ANR Are Pretty Similar
Back in March of this year, I actually recommended both Arch Coal and Alpha Natural as call options on the fate of coal. The premise was that both firms would essentially kick the can for a few more years until coal prices either rebounded or got worse. Both Arch Coal and Alpha Natural have a ton of debt, but the significant thing was how that debt didn’t need refinancing for a few more years. The earliest debt that ACI needs to deal with is due in 2018, while ANR has until 2017. And while two to three years doesn’t seem like much time, it is an eternity for Wall Street.
All ACI and ANR had to do was keep paying their required interest payments on that debt, and plod along until it came due.
Unfortunately, Alpha Natural’s situation went from bad to worse, even after taking measures to control its cash burn by cutting dividends, decreasing capex spending and idling a few of its mines. Coal prices (especially metallurgical coal) have tumbled as key drivers of demand leave the sector, which has continued to cripple cash flows at ANR. That’s why ANR decided not to kick the can anymore and voluntarily filed for bankruptcy protection.
The key word in that phrase was “voluntarily.” And that brings us to Arch Coal.
Like Alpha Natural, ACI doesn’t need to file immediately, but there’s a good chance it will need to soon — especially if its current plan to keep “kicking the can” doesn’t pan out.
Arch Coal’s Plan Could Fall Flat
Back in May, Arch Coal began exploring options with restructuring advisers as it sought to reduce its debt. ACI hammered the point home that it was not looking at bankruptcy protection, and was just exploring ways to cut its hefty debt load through deals with bondholder groups, such as the holders of its later-dated maturities.
The problem is, the holders of the bonds have already balked at the idea of taking a haircut on both principal and interest payments. Arch Coal, however, needs the exchange to help free it of the vicious cycle of high debt and no earnings. Currently, ACI’s debt-to-capital ratio is 79%, and with its continued losses on the earnings front, there’s not enough free cash flow to start chiseling out of that debt.
Already, the swap exchange has raised the ire of ratings agency Fitch. The agency classified the swap as a distressed debt exchange due to the significant discount to its par value. That’s a bad thing. Arch had its credit rating bumped down to “C” in response to the potential swap. That’s just a step above the lowest rating possible. This follows similar downgrades by Standard & Poor’s and Moody’s.
The ratings agencies may be right in their assumptions that the proposed swap would be a bust. According price data compiled by Bloomberg, ACI’s bonds are trading at 56 cents on the dollar. Fitch’s data also revealed that bid prices for Alpha’s bonds are averaging 6%, meaning that the market doesn’t expect ACI to recover too well from its unsecured and second lien debt claims.
All of this means that even though Arch Coal doesn’t want to file for bankruptcy, it might have to as the debt swap most likely won’t succeed. There’s always the possibility to keep kicking the can, but ACI can’t do so forever, and the filing will come eventually.
The situation continues to deteriorate for the coal stocks: Arch Coal’s proposed debt swap is a last-ditch effort by the company to stave off the inevitable bankruptcy filing.
Despite the low price it’s currently trading at, ACI stock is a lost cause and should be avoided at all costs.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.