Just a month or so after announcing it was exploring strategic alternatives, James River Coal (NASDAQOTH:JRCCQ) has missed a debt payment. It also warned that its 2013 results would be delayed and that it could receive a "going concern" warning from its auditors. Is this casualty of coal's downturn a warning sign of more industry pain down the road?
Too much debt
Debt is a double edged sword. When used well it can boost returns and foster growth, when used unwisely or at the wrong time it can sow the seeds of a company's destruction. James River, struggling to survive in a tough coal market, basically has too much debt at exactly the wrong time.
That, interestingly enough, is the exact opposite of Rhino Resource Partners (NYSE:RNO). This relatively small coal limited partnership just announced plans to sell its natural gas drilling assets and, effectively, pay off all of its debt. Commenting on the $185 million transaction, Dave Zatezalo, Chairman of the Board of Rhino's general partner, said, "In an environment where many coal producers are burdened with high debt levels, this will give us great flexibility to opportunistically expand our operations and increase our cash flow."
Rhino might well have singled out James River as a comparison point. But James River isn't the only miner looking at a heavy debt load. For example, Arch Coal (NYSE:ACI) addressed that question directly in its its 2012 annual report when management wrote: "Is Arch's debt level too high for a commodity business? In our opinion, yes."
Arch has made a specific point of building its cash balance so it can survive the coal market downturn. At the end of 2013, a particularly bad year for coal companies, management had squirreled away over $1 billion of cash or equivalents. To help that process along, the company has been selling non-core assets like less desirable coal mines and a mine equipment business (ADDCAR).
Will this ensure survival? Probably. But you should keep an eye on the balance sheet just in case. Alpha Natural Resources (NYSE:ANR) and Walter Energy (NASDAQOTH:WLTGQ) are two others to keep an eye on. Like James River and Arch, Alpha and Walter both have material exposure to metallurgical coal. While it looks like the U.S. thermal market is starting to turn the corner, the more global met market is still struggling with too much supply.
So even if the domestic thermal market starts to pick up, these four miners are likely to continue struggling to turn a profit. Bleeding red ink isn't helpful when it comes to paying your debts. And while each of the four companies is in a different financial position, none of them are debt free like Rhino.
Continuing to diversify
Another company to watch closely is Natural Resource Partners (NYSE:NRP). This limited partnership recently lowered its distribution by $0.20 to $0.35 a unit. That's a hefty drop and could justifiably be looked at as a flashing warning sign. Note that Arch and Walter both trimmed their disbursements, too.
However, Natural Resource has been aggressively expanding beyond coal in recent years and noted that the cut, "...will allow NRP to preserve its liquidity for acquisitions." Still expanding with debt while your core sector is struggling can lead to James River like outcomes if you aren't careful. So Natural Resource Partners should be on the "watch list" if you own it, too.
Not over yet
The coal industry's malaise isn't over yet. Although there are glimmers of light at the end of the tunnel, you need to be prepared for a further shakeout, particularly on the met side of the business. It looks like James River Coal is getting caught in that right now, but keep your eyes on some of the other players, even large ones like Arch and Alpha. There's a huge amount of upside potential, but you have to be careful not to get sucked into a value trap.
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Reuben Brewer has positions in Natural Resource Partners and Rhino Resource Partners. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.