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Looking at Patriot Coal (OTCQB:PCXCQ), it would take the gutsiest investor to get involved. Not only is the company in bankruptcy but it has the EPA and United Mine Workers Association breathing down its neck. But, there is a possibility of its high yield bonds maturing in 2018 as a way to play a restructuring (Cusip 70336TAC8).

In a bankruptcy, usually the attorneys get paid first, banks second, secured bond holders third, and a lot of other people last. Often times, the debt holders will become the equity holders when the company emerges from bankruptcy. The 2018 bonds are currently trading at 46 cents on the dollar.

Let's first look at the coal industry. I'll use Patriot's numbers that show that the U.S. share of coal electricity decreased from 48.3% in 2008 to 37.4% in 2012. This precipitated a drop in the price of thermal coal from $161 a ton in 2008 to $58 in today's market. Much of this is due to horizontal fracturing and competing low natural gas prices. A good article from Seeking Alpha on Patriot is included in this link.

Secondly, Patriot's "Asset retirement obligation expense" rose from over $19 million in 2008 to $354 million in 2012. This involved parts of the Clean Water Act and selenium water treatment. You can bet that this will be the norm going forward for the coal industry.

The 2018 bonds are unsecured but have a chance of being worth something on the other side of bankruptcy. A look at the company's liabilities from its 10-K look like this:

December 31, 2012

(Dollars in thousands)

  • Postretirement benefit obligations, excluding Coal Act $ 1,517,284

  • Unsecured debt 458,500

  • Interest payable 4,838

  • Rejected executory contracts and leases 151,449

  • Trade payables 78,086

  • Other accruals 52,150

Total Liabilities subject to compromise $ 2,262,307

The $64,000 question is what will be negotiated in regards to the $1.5 billion in postretirement obligations. The company has obtained what will be up to $802 million in loans that will be senior to everything above.

The nicest asset is the 1.8 billion tons of proved and probable reserves of coal in the ground. A back of the envelope calculation says that 1.8 billion times $58 per ton of coal equals $104.4 billion.

Conclusion: With $104.4 billion of coal in the ground, Patriot's bonds have to be worth something even if they don't have first claim on assets. It's a high risk trade for someone who has the stomach to go through the bankruptcy process.

Source: Patriot Coal Bonds Show Potential In Bankruptcy