This article is the result of a commenter's suggestion. The suggestion consisted of investigating what James River Coal (JRCC) looked like just prior to filing bankruptcy back in 2004, and how it looks like today. This was to be done using the same methodology I used to estimate the risk for the other coal (KOL) plays -- Patriot Coal (PCX), Arch Coal (ACI), Alpha Natural Resources (ANR), and Peabody Energy (BTU) -- in my article "Revisiting The Coal Sector With An Alternate Altman Z-Score Model."
The first thing I should say, before I go any further, is that this investigation will do two things: confirm the usefulness of the methodology in question for the mining industry (it would have correctly predicted the 2004 bankruptcy by James River Coal), and produce a huge surprise.
First, the methodology:
Again, I will be using the alternate Altman Z-score, whose changes from the original model consist of the following:
- The alternate model does not include T5;
- In the alternate model, T4 = Book Value of Equity / Total Liabilities;
- The weights are different, with Z = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4; and
- The interpretation of the results is done according to a different set of values (Z > 2.6 is safe; 1.1 < Z < 2.6 is the grey zone; Z < 1.1 is the distress zone).
This Z-score is more adequate for non-manufacturing companies, namely those that -- like the mining companies -- are incredibly capital-intensive.
Calculation for James River Coal, using 2003 end-of-year data and present-day data:
The following data was sourced from James River Coal earnings reports (2004 -- includes 2003; and 2012, latest 10-Q):
With this data, we obtained the following results:
Interpretation
The 2003 data left no doubt: The Z-score was deep in the danger zone (Z = -2.00 < 1.11). James River Coal was on a straight path to bankruptcy, and indeed filed during 2004.
Today's data, however, brings a huge surprise. Even though we usually put James River Coal in the same pack as Patriot Coal, the truth is that when using the Z-score they couldn't be much more different. James River Coal scores in the grey zone (Z = 1.35), a score in all respects similar to Arch Coal's or Alpha Natural Resources'. This is hugely helped by James River's careful management of its working capital, with current assets largely exceeding current liabilities, and with James River holding a substantial amount of its current assets in cash. Although the overall score might be a little too flattering as it also leans on 2011's EBIT, there's no doubt that James River Coal is in an entire different division when compared to Patriot Coal. And that is the huge surprise here.
Conclusion
As I already stated, there are two main conclusions to be drawn from this work:
- The alternate Altman Z-score would have been useful in predicting James River's bankruptcy back in 2003, and so might be useful today to gauge insolvency risk in other coal companies; and
- James River Coal's present risk as gauged by the Altman Z-score is comparable to Arch Coal's or Alpha Natural Resources', and quite a bit different (and lower) than Patriot Coal's -- which is a big surprise.
Given these conclusions, it might make sense for those betting on a coal recovery to also consider James River Coal in their long portfolios.
