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Earlier this week, coal producer Patriot Coal (PCX) filed for bankruptcy protection. Only a year ago, Chinese demand looked robust, coal prices were decent, and the company was trading at $25 per share. Though the firm will continue to operate during its restructuring, the bankruptcy speaks volumes about the broader industry. With coal industry economics deteriorating, the highly leveraged players could be in trouble.

Thanks to an abundance of natural gas recently discovered in the United States and Russia, natural gas prices have fallen drastically, especially in the past year. This lower pricing, combined with support for "clean" energy policies, has contributed to a severe slump in demand for coal, especially in the United States. Further, because mining coal is extremely energy-intensive itself, the high price of oil has contributed to higher coal input costs. Even in China, where environmental policies may be less stringent, demand has slumped as the rate of economic growth has leveled off slightly. With lower prices in China, the economics of exporting coal just aren't very attractive, in our view.

James River Coal is not immune to these troubles. In fact, the share price of James River Coal (JRCC) fell about 20% after confirmation of Patriot Coal's bankruptcy. Further, debt accounts for approximately 88% of James River's capital structure, and the firm faces obligations of roughly $70 million in this year alone. Given that the company generated negative cash flow of $30 million in the first quarter, James River will likely have to tap some of its $208.5 million in available liquidity. This includes $169 million in unrestricted cash, $29.6 million in restricted cash, and the balance coming from its revolving credit agreement. Liquidity is a valid concern at James River, in our view, and the firm doesn't score that great on our Valuentum Buying Index (our stock-selection methodology). We'd continue to be cautious even at these depressed levels.

Essentially, any coal miner that only owns mines in the US like James River Coal, Cloud Peak (CLD), Alpha Natural Resources (ANR) or Arch Coal (ACI) will face challenges in the near term due to the currently unfavorable conditions in the industry. We suspect low-cost producers in the Powder River Basin, like Cloud Peak, will be able to handle industry weakness better than most. Cloud Peak and Peabody Energy (BTU) are not as highly leveraged as James River or Arch Coal, and both look cheap based on our normalized DCF valuation (which assumes a moderate rebound in coal prices). However, both Cloud Peak and Peabody register low scores on our Valuentum Buying Index, so we'd wait for material technical improvement before considering a position in the portfolio of our Best Ideas Newsletter. We think things will get worse in the coal industry before they get better.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: We're Concerned About James River's Liquidity