By Greg Ruel, Senior Research Associate
Recent cash tender offer results at coal supplier Alpha Natural Resources, Inc. (ANR) sparked the attention of GMI Ratings. On September 27, the company issued new debt, offering up $500 million in senior notes backed by Alpha subsidiaries and priced at an interest rate of 9.75%. The interest rate is 200% higher than the 3.25% rate of Convertible Senior Notes due 2015. The high interest rate on the most recent offering is the result of the company’s leverage ratio, with variable rates that increase as the company’s leverage ratio increases. Indeed, second quarter results showed $2.2 billion in losses at Alpha Natural, mainly due to restructuring and impairments. A declining leverage ratio, increasing debt, and consistent legal problems collectively threaten to push Alpha Natural’s ESG Rating of “D” into failing territory for long-term risk.
Based on financial statements, Alpha Natural's risk of bankruptcy or financial distress has continued to increase, according to GMI Ratings' Distress Model Score Trend. The company has declined from moderate distress risk in October 2011 to a ranking in the 2nd percentile of all companies in North America; indicating higher chance of financial distress than 98% of comparable companies rated by GMI Ratings. Alpha Natural Resources, Inc. currently has a 9.3% probability of financial distress in the next 12 months.
The GMI Ratings Litigation Risk Model has also indicated Alpha Natural as "High Risk" for shareholder class action litigation since October 2011. However since the start of 2012, the company has placed in either the second or third percentile each month, indicating higher shareholder class action litigation risk than 98%-97% of all rated companies in North America. In addition to company size and industry classification, the litigation model tracks adverse stock performance, an indicator of damage to shareholders. Since the start of 2011, Alpha Natural's stock price has declined by more than 85 percent, and there's been a rash of shareholder litigation coincident with the drop.
GMI Ratings has flagged Alpha Natural Resources for Social Impact Investigations, Workplace Safety Policy, and Workplace Safety Record Reporting. Since January 2011, the company has received 18 different imminent danger orders related to its subsidiaries. Several of the violators are repeat offenders, with AMFIRE Mining Company, Brooks Run Mining Company, Dickenson-Russell Coal Company, Cloverlick Coal Company, all receiving multiple safety infractions over the past two years. Two additional subsidiaries, Support Mining Company and Marfork Coal Company Inc., received notices for Potential Pattern of Violations ("PPOV").
Moreover, settlements and levied fines against Alpha Natural have been significant- especially since the Massey acquisition. In December 2011, the company came to a settlement of more than $200 million with the U.S. Department of Justice, among others, resolving proceedings against Massey Energy related to an April 2010 mine explosion that killed 29 miners. Penalties included an $80 million investment in added safety measures at legacy Massey mines, $48 million placed in a trust to fund mine safety research, $46.5 million paid to victim's families, and $34.8 million to resolve citations and violations. In February, the U.S. attorney's office charged a former mine superintendent at Massey Energy with conspiring to obstruct regulators prior to the 2010 explosion. The employee was charged with being complicit in a broader conspiracy leading up to the accident, resulting in a downgrade of its ESG Rating to "D" by GMI Ratings.
On March 21, the day after Chairman and former Alpha Natural CEO Michael Quillen announced he was leaving the board, a report was released by corporate business intelligence group SNL Financial, stating that "Alpha Natural Resources were assessed more fines for federal mine safety and health violations last year than all other major publicly traded coal companies combined [$33 million compared to the to $30 million assessed to the 11 other major coal owners combined]." A spokesperson for SNL Financial also said the findings provide "evidence that the company continues to struggle to bring former Massey Energy co. operations into compliance", citing that Alpha "racked up nearly as many proposed fines in 2011 as Alpha and Massey did combined in 2010." On May 17, an experienced worker at the company's Liberty coal plant died after a fall at the plant.
A reduced dependency on coal across the globe has caused mine closings and layoffs. In June 8, the company announced it would cease production in four Kentucky mines and idle two others, thereby cutting 150 jobs. Alpha's chairman and CEO Kevin Crutchfield added, "This year, utilities in the U.S. are expected to burn the least amount of steam coal than at any time in the last 20 years." In July, an article in the Washington Post detailed the rapid decline in U.S. coal use; citing the advent of cheap natural gas, which now ties coal as America's top source of electricity, and EPA rules on air pollution instituted by President Obama, which have caused coal companies to spend more to regulate emissions.
On September 18, Alpha Natural announced additional layoffs, with the idling of eight mines in Virginia, West Virginia, and Pennsylvania. Consequently, 1,200 jobs were cut, the equivalent to 9 percent of its workforce. Of the latest layoffs, Mr. Crutchfield said, "Cheap natural gas prices and a regulatory regime that is overtly designed to constrain the use of coal has created a double edged sword for us."
Furthermore, the company has experienced precipitous declines in total revenue and gross profit in each interim period since September 30, 2011. Over this period, total revenue has dropped by about 20 percent, from $2.3 billion to $1.8 billion, while gross profits have been halved, from $322.7 million to just $158.9 million. Alpha Natural's margins are also well behind the industry average. Based on the trailing 12 months, the company's Gross Profit Margin of 11.4% is well below the industry average of 25.8%, EBITDA Margin is 11.4% against an industry average of 20.2% and Alpha's Net Income Margin of -36% in no way compares to the industry average of 4.5%.
Most recently, Alpha Natural Resource's shrunken market cap has caused its ouster from the S&P 500. As of the close of trading on October 1, the second-largest U.S. coal producer was moved to the S&P Midcap 400 Index, "because its market value is too low", S&P said. Coal is having a hard time competing with the influx of cheaper natural gas, which is now flowing so fast into U.S. pipelines that experts debate what to do with it all. Not only is the coal industry as whole in a battle with less expensive and safer alternatives, but in addition, Alpha Natural remains entangled in legal issues and struggling to raise capital as profitability plummets and its long-term sustainability remains shrouded in doubt.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.