The problems at James River Coal (NASDAQOTH:JRCCQ) were becoming increasingly obvious as 2013 drew to a close, but the crescendo was missing a debt payment in mid-March. In fact, the miner's early-April Chapter 11 filing is almost anticlimactic. But it highlights the continuing dangers facing coal miners. So which might be the next to fall?
An issue of steel
Broadly speaking, there are two sides to the coal industry: thermal coal used in power plants and metallurgical coal used in steelmaking. Even though the thermal side of the industry has suffered through a domestic downturn because of relatively low natural gas prices, well-positioned miners have held their own and continue to turn a profit.
Although avoiding red ink was touch and go for some, focusing on cost containment has allowed these miners to remain in the black. And now that Powder River Basin coal prices are hitting two-year highs, there's a silver lining starting to form on the thermal coal cloud.
This is in stark contrast to metallurgical coal, where prices remain relatively weak and there's not much hope of a pricing upturn until late this year or early 2015. About half of James River's coal business is met coal. The bigger problem, however, is that it bought into the metallurgical arena when met coal prices were much higher. That saddled the company with debt that, in hindsight, it couldn't afford.
A very similar story has played out at Arch Coal (NASDAQOTH:ACIIQ), which bought into metallurgical coal at the peak using debt. Now that this sector is out of favor, Arch is working hard to ensure it has enough cash to survive. It had about $1 billion at the close of 2013, and it sold two business this year in an effort to raise even more.
Last year, met coal made up about 20% of the company's business and PRB thermal coal 45%. With PRB starting to pick up, it looks like Arch will survive, but it's worth keeping an eye on the company's balance sheet just in case. That's particularly true since the last two years have each seen losses of over $3 a share. That's a trend that can only last for so long before it becomes a big problem, particularly with Arch's long-term debt hovering around $5 billion (about 70% of the capital structure).
In fact, the coal market downturn has already led to the near elimination of the company's dividend. In 2011, Arch paid a full-year dividend of $0.43 a share. The run rate today is $0.04, which is little more than a token.
Debt refinancing efforts at Walter Energy (NASDAQOTH:WLTGQ) should also be on your radar screen. This company generates almost 90% of its revenue from met coal and recently issued debt with a payment in kind, or PIK, provision. That's great if Walter runs into financial problems because it lets the company issue new debt to bondholders instead of paying them in cash. But it suggests that Walter is preparing for a day when it has to do that.
Like Arch, Walter has been losing money over the last two years. And with a focus on met coal, that's not likely to change in 2014. At the start of the year, long-term debt was about 80% of Walter's capital structure. So Walter might actually make use of that PIK provision sooner than its new bondholders hope. If it does, look for the shares to drop even further.
The ends of the spectrum
Watching James River go down should make you worry about Walter and other miners heavy into met coal, as well as more diversified miners with notable debt loads, like Arch. There are signs that coal is starting to turn the corner, but that hasn't happened yet and there's still enough pain in the market to take a weakened miner down.