James River Coal: Assessing The Risk Of Bankruptcy

Apr.18.13 | About: JAMES RIVER (JRCCQ)

As of April 16, James River Coal (JRCC) is down 74% from its 52-week high of $5.89. The US coal industry faced an extremely tough 2012, with steep price declines in both thermal and metallurgical coal. As a higher cost producer, James River Coal was especially affected by the price declines, and has generated concerns about bankruptcy due to its heavy debt load.

We are going to look at James River Coal's performance under several different scenarios during 2013, and assess the chances that they will file for bankruptcy.

2013 Becomes A Metallurgical Coal Story

James River Coal essentially has all its thermal coal production for 2013 already committed and priced. They recently announced that they had reduced production by 3 million tons, meaning they may only have 2.787 million tons of CAPP thermal coal production capacity left (based on FY2012 production numbers). On the other hand, James River Coal had already entered into contracts to deliver 5.012 million tons of CAPP thermal coal in 2013 at an average price of $81.39 per ton. Therefore, all their remaining CAPP thermal coal production is already committed, and they will need to make up the shortfall by purchasing CAPP thermal coal from third parties.

James River Coal also has contracts to deliver 2.544 million tons of Midwest thermal coal at an average of $45.04 per ton. This exceeds the 2.327 million tons of Midwest thermal coal they produced in 2012, so it is likely that all their Midwest thermal coal is already committed and priced.

Therefore, with the thermal coal prices and production essentially set, James River Coal's 2013 outlook will be determined by metallurgical coal pricing.

Thermal Coal Revenues and Margin

After the production cut, James River Coal might only produce 2.787 million tons of CAPP thermal coal. Since they have contracts to deliver 5.012 million tons, the remaining amount will need to be purchased from third parties. James River Coal's cost of producing CAPP thermal coal was $79.17 per ton during FY2012. We are going to assume that this increases to $80 per ton in FY2013, and that they are able to purchase CAPP thermal coal for $70 per ton. This latter figure is above the current $67 per ton spot price.

James River Coal's cost of producing Midwest thermal coal was $38.85 per ton during FY2012. We are going to assume that this cost goes up to $39.50 per ton during FY2013.

Metallurgical Coal Pricing

The price of metallurgical coal declined sharply in the 2nd half of 2012, but has started to make a recovery since then. James River Coal sold 3.614 million tons of metallurgical coal during 2012, but had a higher sales rate of 982,000 tons in Q4 FY2012. We are going to estimate metallurgical coal sales at 4 million tons during 2013.

Metallurgical coal pricing varies according to the quality of the coal. The below table shows the prices that James River Coal was able to get for their metallurgical coal during 2012.

Period

Q1 FY2012

Q2 FY2012

Q3 FY2012

Q4 FY2012

FY 2012

Met Coal Revenue Per Ton

$141.72

$128.85

$114.30

$107.33

$121.54

Click to enlarge


Their cost per ton of metallurgical coal was $100.47 per ton during 2012. A portion of their metallurgical coal is purchased from other producers, so declines in prices also helps reduce their metallurgical coal costs by a bit.

We have identified three scenarios for metallurgical coal pricing during 2013. Prices for metallurgical coal of quality similar to James River Coal's offerings seem to be around $110-115 per ton during Q1 FY2013.

Scenario 1: Flat metallurgical coal pricing @ $110 per ton

James River Coal received an average of $107.33 per ton for metallurgical coal during Q4 FY2012. Coal prices have rebounded somewhat since then, but this scenario assumes that pricing remains stable or declines slightly from Q1 FY2013 levels throughout the rest of 2013. Since prices are lower than the 2012 average, we are assuming the cost per ton to go down to $99.

Tons (Million)

Revenue ($ Million)

Cost of Coal Sold ($ Million)

Gross Margin ($ Million)

CAPP Thermal

5.012

$407.93

$377.84

$30.09

CAPP Met

4.000

$440.00

$396.00

$44.00

Midwest

2.544

$114.58

$100.49

$14.09

Total

11.556

$962.51

$874.33

$88.18

Click to enlarge

Scenario 2: Modest recovery in metallurgical coal pricing to $120 per ton

This scenario assumes a continued recovery in metallurgical coal, with pricing in the 2H of 2013 reaching around $125/ton. Thus full-year prices will average $120 per ton compared to $121.54 per ton for FY12. Cost per ton is pegged at $101.

Tons (Million)

Revenue ($ Million)

Cost of Coal Sold ($ Million)

Gross Margin ($ Million)

CAPP Thermal

5.012

$407.93

$377.84

$30.09

CAPP Met

4.000

$480.00

$404.00

$76.00

Midwest

2.544

$114.58

$100.49

$14.09

Total

11.556

$1,002.51

$882.33

$120.18

Click to enlarge

Scenario 3: Strong recovery in metallurgical coal pricing to $130 per ton

This scenario assumes a strong recovery in metallurgical coal, with pricing in the 2H of 2013 reaching over $140/ton. Full-year prices will average $130 per ton. For this scenario to occur during 2013, there would have to be major supply disruptions (akin to the Queensland floods) and/or a significant and accelerating recovery in the global economy. Cost of coal is set at $103.

Tons

(Million)

Revenue ($ Million)

Cost of Coal Sold ($ Million)

Gross Margin ($ Million)

CAPP Thermal

5.012

$407.93

$377.84

$30.09

CAPP Met

4.000

$520.00

$412.00

$108.00

Midwest

2.544

$114.58

$100.49

$14.09

Total

11.556

$1,042.51

$890.33

$152.18

Click to enlarge

Effect on EBITDA and Income

James River Coal is likely to continue to record significant net losses during 2013. However, since the main item affecting income is depreciation, depletion and amortization, it is probably more worthwhile to focus on projected cash flows when trying to assess James River Coal's bankruptcy chances.

SG&A is estimated at $58 million vs. FY2012 actuals of $59.9 million. James River Coal projected that DD&A (Depreciation, depletion and amortization) would be $130 million in 2013.

All Figures in $ Millions

Scenario 1

Scenario 2

Scenario 3

Gross Margin

$88.18

$120.18

$152.18

SG&A

$58.00

$58.00

$58.00

EBITDA

$30.18

$62.18

$94.18

DD&A

$130.00

$130.00

$130.00

Interest Expense & Revolver Cost

$38.00

$38.00

$38.00

Income Before Taxes

($137.82)

($105.82)

($73.82)

Click to enlarge

Effect on Liquidity

James River Coal started 2013 with $135.9 million in available liquidity, of which $127.4 million was unrestricted cash. They provided estimates of $70 million for capital expenditure in 2013 vs. $81.6 million during 2012. The interest expense for long-term debt in 2013 was expected to be $34 million, while the fees under the revolver for letters of credit were expected to add another $4 million.

All Figures in $ Millions

Scenario 1

Scenario 2

Scenario 3

Beginning of Year Available Liquidity

$135.90

$135.90

$135.90

EBITDA

$30.18

$62.18

$94.18

Capital Expenditures

$70.00

$70.00

$70.00

Interest Expense & Revolver Cost

$38.00

$38.00

$38.00

Projected Year End Liquidity

$58.08

$90.08

$122.08

Click to enlarge

Conclusion

In scenario 1 (metallurgical coal pricing of $110 per ton), James River Coal will be in a tough position by the end of 2013. With liquidity down to $58 million and metallurgical coal prices struggling to recover, James River Coal would likely run out of cash during 2014 even with a recovery in thermal coal prices to the pricing achieved in 2011.

In scenario 2 (metallurgical coal pricing of $120 per ton), James River Coal will be in reasonable shape starting 2014. They will still need some thermal coal price recovery to edge back from a liquidity crisis though. Achieving 2013 thermal coal prices for 2014 will leave them with an EBITDA of around $80 million in 2014. Combined capital expenditures and interest of $108 million again would push their cash position lower. However, if they could achieve $90 per ton for CAPP thermal (similar to the 2011 rate) and $47 per ton for Midwest thermal coal, then they could reach around $115 million in EBITDA, marginally improving liquidity during 2014.

In scenario 3 (metallurgical coal pricing of $130 per ton), James River Coal will be in strong shape starting 2014. With metallurgical coal pricing starting 2014 likely to be around $140 per ton in this scenario, bringing EBITDA to $135 million even without a thermal coal price recovery. If they can achieve $90 per ton for CAPP thermal and $47 per ton for Midwest thermal coal, then EBITDA could reach $170 million. In both cases their liquidity will improve significantly, and they have a good chance of being able to raise additional debt at a reasonable rate to pay off their 2015 maturity debt.

James River Coal has done an excellent job under tough circumstances recently to reduce costs and improve efficiency. That has enabled them to survive a very tough period for the coal industry. However, they aren't entirely out of the woods yet. Investors should keep a close eye on the trends in the metallurgical coal market and the prices that James River Coal is able to get for their metallurgical coal. Other things to monitor include trends in natural gas prices and CAPP thermal coal futures. To be optimistic about their future prospects would require indication that they are getting at least $120 to $125 per ton for metallurgical coal by the end of 2013, and ideally show that they are signing thermal coal contracts for close to $90 per ton for CAPP thermal.

There is a lot of potential reward in James River Coal long term, as the most optimistic scenario of $170 million in EBITDA in 2014 could make the company worth over $10 per share. Even $115 million in EBITDA could make James River Coal worth $5 per share based on an EV/EBITDA ratio of 5-6. However, a metallurgical coal market that remains weak into 2014 will likely put the company into extremely serious danger of bankruptcy, and a weak thermal coal market would keep them struggling to remain afloat even with a modest increase in metallurgical coal prices. Investors should be cognizant of these risks, as James River Coal is a high risk and a high reward stock.

Disclosure: I am long JRCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.