Why James River Coal Will Likely Follow Patriot Coal Into Bankruptcy

Jul. 9.12 | About: JAMES RIVER (JRCCQ)

A lot of Seeking Alpha readers were asking me about James River Coal (JRCC) in the comments section of my article yesterday: James River Coal And Patriot Coal Will Likely Retest Lows.

They were wondering if James River will follow Patriot (PCX) into bankruptcy. With the way things are going, my opinion is that JRCC is definitely going bankrupt.

However, it's not going to happen tomorrow, and probably not this year. It probably will happen in early-to-mid 2013. A big reason why is because the big players are going to shut JRCC out of the market.

Now that it's a clear bankruptcy risk, JRCC won't be able to get any more financing. The PCX bankruptcy was an unfortunate event for JRCC. Any business partners JRCC gets will demand immediate payment. Therefore, JRCC is going to have to be very careful with how it spends its money. This includes marketing dollars. While the bigger players like BTU, WLT, and ANR are aggressively trying to suck up any extra possible coal demand in Europe, China and India, JRCC is stuck in the muck, hoping for a miracle that will most likely never come.

It's easy to see why PCX filed for bankruptcy on July 9th, it was simply out of cash. Looking at its March 31, 2012 statement of cash flows, it shows that PCX burned $79.7 million in cash last quarter. It reported a $114 million cash balance last quarter. Therefore, it probably burned about $110 million in cash this quarter, or about 37% more than last quarter.

Looking at the March 31, 2012 statement of cash flows for JRCC, it shows a cash burn of $30.2 million. Now assuming the cash burn also increased by 37% quarter on quarter for JRCC, that puts it at $41 million this quarter. JRCC's total liquidity on March 31, 2012 was $208.5 million, consisting of $169.4 in cash, and $39.1 million from its revolving credit facility. JRCC will likely break its covenants by the end of the year, so that leaves only its cash balance of $169.4 million for liquidity.

Last month, S&P downgraded JRCC to CCC+. S&P believes that for the entire year 2013, high coal inventories and low natural gas prices are likely going to keep coal prices weak. Also, with the slow global economy, steel demand will continue to be weak. While many coal companies can survive through a tough 2013 year without going bankrupt, JRCC cannot.

Another big reason for this downgrade is because the majority, about 72%, of JRCC's coal is produced from the Central Appalachia (OTCQB:CAPP) basin. CAPP is one of the most expensive places to mine coal. It is becoming even more expensive because the coal seams are mature and thinning. JRCC's thermal coal production costs in CAPP are about $70 to $80 per ton. If JRCC has to shut down one of its CAPP coal mines because it costs too much, then it's game over, since that is where most of its production comes from.

Disclosure: I am short JRCC.