Patriot Coal's (PCX) stock may have rallied on Wednesday, but guess what didn't rally: its senior unsecured debt. The day after bankruptcy rumors hit the press, Patriot Coal's stock rose 22.02%. In fact, it nearly doubled off its Tuesday low of $1.36. However, despite the rebound in the stock, Patriot Coal's 4/30/2018 maturing, 8.25% coupon, senior unsecured note, CUSIP 70336TAC8, did not rally.
Currently asking 49 cents on the dollar and yielding 25.319%, this note with $250 million outstanding now carries Caa2/CCC ratings from Moody's and S&P respectively. Now here's the interesting thing: Moody's LGD rate (loss given default) on Patriot Coal's senior unsecured debt is currently 60%, meaning a 40% recovery is expected. At this time, S&P is projecting a recovery of 50%-70% in the event of a payment default. With the bond asking 49 and the two major rating agencies currently projecting recoveries between 40 and 70 cents on the dollar, if you are planning to invest in Patriot Coal, it might make more sense to buy the bond.
If you purchase the stock and the company files for bankruptcy, you are likely to lose nearly 100% of your investment. If you purchase the bond, currently yielding 25.319%, and the company defaults on its obligations, the rating agencies are projecting recoveries that would result in anywhere from an 18.37% loss to a 42.86% gain on the position. Of course, the rating agencies could be wrong. However, before you go bottom fishing in Patriot Coal's stock, spend a bit of time considering the message the bond market is sending about this company's future. Also, spend some time considering whether an investment in the bond, rather than in the stock, would make more sense given the projected recovery rates outlined above.
It should be noted that investments in high-yield debt carry significant risks. While I am an investor who buys individual bonds, including junk bonds, I do not purchase individual bonds with ratings that begin with a "C." Instead, I prefer to use a high-yield ETF such as HYG when I want to gain exposure to the lowest reaches of the junk bond world.
Furthermore, as it pertains to companies with heavy exposure to coal, I am long the bonds of only three companies: Peabody Energy's (BTU) 9/15/2020 maturing, 6.50% coupon, senior unsecured note, CUSIP 704549AH7; Alpha Natural Resources' (ANR) 6/1/2021 maturing, 6.25% coupon, senior unsecured note, CUSIP 02076XAC6; and CONSOL Energy's (NYSE:CNX) 3/1/2021 maturing, 6.375% coupon, senior unsecured note, CUSIP 20854PAH2. Moreover, I am long the stock of just one company, Peabody Energy, using a strategy similar to that outlined in my article "A Different Way To Play ArcelorMittal."
Disclosure: I am long BTU, HYG.
Additional disclosure: I am long BTU, ANR, and CNX bonds.