James River Coal: Expectations For Q3 Earnings And Its Future

| About: JAMES RIVER (JRCCQ)

James River Coal (JRCC) is set to report Q3 FY2013 earnings on November 7. We had previously estimated James River Coal's chances of bankruptcy by the end of 2014 at 75% and are increasing that estimated chance to 85% based on coal market developments since that time. While we believe that most coal companies will rebound significantly, James River Coal is hampered by high costs of production (as evidenced by its shutdown of most CAPP thermal coal production) and near-critical liquidity levels. The coal market recovery is likely coming too late and improving too slowly to save James River Coal. The one remaining hope is for a supply shock to the metallurgical coal markets that causes prices to appreciate very rapidly.

Q3 and Q4 FY2013 Expectations

James River Coal's thermal coal prices were largely already set for 2013. Metallurgical coal prices declined for other American producers in Q3, but have rebounded in Q4. For example, Alpha Natural Resources (ANR) recorded a 6% sequential decline in metallurgical coal prices in Q3, but the benchmark price for metallurgical coal increased 5% in Q4.

Based on that information, we'd expect that James River Coal will post a larger adjusted EBITDA loss in Q3 (over $5 million) but may approach $0 EBITDA in Q4. Working capital will likely be in the $85 million to $90 million range for Q3 and $60 million to $65 million range for Q4 as a result.

Thermal Coal Outlook

When we wrote about James River Coal last, we estimated that there would need to be a 12% increase in the price of CAPP thermal coal for James River Coal to reach break even with its production costs. After two months, the price has increased by approximately 4%, although it reached a peak of approximately 8% higher in mid-October.

However, the CAPP thermal coal price may not matter much since James River Coal has idled its McCoy Elkhorn and Bledsoe mines as well as its Long Branch Surface mine. These mines accounted for 3.7 million tons of production in 2012 and represent the majority of James River Coal's remaining CAPP thermal production. In October, it determined that these operations will not restart during the next six months and estimated severance costs of $5.8 million in Q4. We are not too sure exactly how much of James River Coal's CAPP thermal production is remaining, but it is likely approaching zero since 6.7 million tons of production capabilities have been idled since late 2012.

Since James River Coal's CAPP thermal mines appear unlikely to make positive contributions, there is more pressure on its Midwest operations to deliver strong margins.

Illinois Basin coal prices remain steady, but have not increased significantly over the last year. At current spot prices, James River Coal would only make around $5 million in contribution margin, but futures contract prices may be significantly higher, so we are still assuming that James River Coal can make around $20 million in contribution margin from its Illinois Basin coal in 2014.

Quarter

Average Per Ton (Illinois Basin)

Q1 2012

$53.78

Q2 2012

$47.53

Q3 2012

$43.58

Q4 2012

$38.57

Q1 2013

$38.85

Q2 2013

$40.06

Q3 2013

$39.22

Current

$39.00

Click to enlarge

Source: Platts Coal Outlook

Metallurgical Coal Outlook

The benchmark for metallurgical coal increased to $152 per ton in Q4 versus $145 per ton in Q3. This is down from $172 per ton in Q2 however. James River Coal's metallurgical coal prices do not correlate exactly to the benchmark, but it is likely that it will receive around $90 or less per ton of its metallurgical coal in Q3.

We estimate that James River Coal will need to average over $115 per ton of metallurgical coal sold in 2014 to avoid running completely out of liquidity by the end of 2014, and over $125 per ton to avoid going under $20 million in liquidity by the end of 2014.

Key Points To Look For During Q3 Earnings

Working Capital. This will give us a better picture of James River Coal's financial health than its liquidity position, which can be affected by changes in items like accounts receivable. In Q2 FY2013, James River Coal's liquidity position was nearly unchanged, but that was mainly accomplished through a decrease in accounts receivable of $40.3 million. Working capital decreased by $28.1 million from Q1.

Contracted Thermal Coal Pricing. Thermal coal prices are often fixed via contracts agreed to well in advance of the delivery date. By November 2011, James River Coal had priced 2.776 million tons of Midwest coal for the following year. By November 2012, James River Coal had priced 2.342 million tons of Midwest coal for the following year. We know what price James River Coal will get for most of its Midwest coal in 2014 if that trend continues, although James River Coal may need to gamble that prices will increase significantly in coming months and therefore may not have locked in prices yet.

CAPP Thermal Coal Production. Is there any CAPP thermal coal production remaining after 6.7 million tons of production has been removed since late 2012?

Reductions In Capital Expenditures & SG&A. We had previously forecast $45 million in capital expenditures and $55 million in SG&A for 2014. However, these numbers may decline somewhat due to the CAPP mines being placed in maintenance mode now.

Conclusion

The relatively slow rebound in the coal market has taken James River Coal to near the end of its runway. Despite solid management of costs and debts, it appears that there is little more that James River Coal can do to avoid bankruptcy. Perhaps James River Coal will have a surprise in its Q3 FY2013 earnings call, but the combination of high cost production, low levels of liquidity and a slowly recovering coal market has made it very difficult to see a way for James River Coal to avoid bankruptcy by the end of 2014. It appears that James River Coal will most likely fall below $25 million in working capital during Q2 FY2014. Investors looking to capitalize on a rebound in coal markets would be better advised to seek out companies with lower production costs and enough liquidity to wait out a gradual rebound in prices.

Disclosure: I am short 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.