The Canary In Patriot Coal's Mine Is Dead

| About: Patriot Coal (PCXCQ)
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The canary in Patriot Coal's (PCX) mine is dead. On Monday, Patriot Coal filed for Chapter 11 of the Bankruptcy Code in the Bankruptcy Court for the Southern District of New York. The company also announced that it has obtained a commitment for $802 million in debtor-in-possession financing. Not surprisingly, Patriot Coal's shareholders are suffering a brutal sell-off, as the stock first sold off 72.10%, to $0.611, during the regular trading session when news of a potential bankruptcy filing first broke. Then, after the filing became official, the stock continued lower, trading as low as $0.34 in after-hours trading. Furthermore, the stocks of other coal companies, including Peabody Energy (BTU), Alpha Natural Resources (ANR), Arch Coal (ACI), and James River Coal Company (JRCC), also reacted quite negatively to the Patriot Coal news.

However, I'd like to use this opportunity to point out that this news was no news to the bond market. Patriot Coal's 4/30/2018 maturing, 8.25% coupon, senior unsecured note, CUSIP 70336TAC8, did trade in a wide range on Thursday with every single trade hitting the market after news of the imminent bankruptcy broke. But, the bond not only failed to make a new 52-week low, but the asking price on the bond finished the day at 37 cents on the dollar, 32.93% above the 52-week low. While shareholders were watching the remaining value of their investments get destroyed, the bond market continued doing what it's been doing for several weeks now: positioning for recovery rates.

While the bond market doesn't get it right every time, when company- or industry-specific weakness is driving bond prices and credit ratings lower, versus widespread weakness across the high-yield market driving bond prices lower, shareholders should pay extra close attention. In other words, the bond market may make mistakes when all industries are getting sold off, such as during a recession, but when the issues are company- or industry-specific and the bond market is pricing in a bankruptcy, shareholders better take that very seriously. Keep in mind that in general, bondholders are most concerned with a return of their capital while equity investors are generally more obsessed with a return on their capital.

On July 5, just two trading days before Patriot Coal filed for bankruptcy, the stock traded as high as $2.62. At the exact same minute the stock reached $2.62, more than double its share price of just two days prior, the bond was yielding 30.165%. The moral of this story: When the bonds of a company whose stock you own are screaming bankruptcy, shareholders should, at a minimum, hedge themselves, if not outright sell.

With that in mind, let's take a brief look at the senior unsecured bonds for the other coal companies mentioned above:

Peabody Energy's senior unsecured notes, rated Ba1/BB+ by Moody's and S&P respectively, continue trading over par. They've been the strongest of the bunch throughout the brutal times the coal industry is going through and continue as the strongest to this day. The yields-to-maturity on Peabody Energy's four to fourteen year bonds, based on the closing offers from Monday range from 4.259% to 7.201%.

Alpha Natural Resources' senior unsecured notes, rated B2/BB- by Moody's and S&P respectively, have generally been hovering in the mid-80s to low-90s for many weeks. The Moody's downgrade of Alpha Natural Resources' senior unsecured bonds from Ba3 to B2 on June 27 did little to change that range. The yields-to-maturity on Alpha Natural Resources' seven and nine year bonds, based on the closing offers from Monday are 8.533% and 8.261% respectively.

Arch Coal's senior unsecured notes, rated B3/B- by Moody's and S&P respectively, have generally maintained yields in the 8.50% to 10.50% range for four to nine year debt. Similarly to Alpha Natural Resources, Arch Coal's senior unsecured debt was downgraded by Moody's on June 27, from B2 to B3. Also similarly to Alpha Natural Resources, Arch Coal's bonds did not respond negatively to the downgrade, implying the bond market was a step ahead of the rating agencies.

Finally, James River Coal Company's 4/1/2019 maturing, 7.875% coupon, senior unsecured note, CUSIP 470355AG3 is one to keep a close eye on as it closed Monday with an offer of just 52 cents, to yield 21.79% to maturity. Its credit rating of B2/B- by Moody's and S&P respectively is still in the same ball park as the ratings of Alpha Natural Resources and Arch Coal, despite the James River Coal Company bond trading far worse than those competitors' bonds. Interestingly, Moody's is currently predicting only a 34% loss on the bonds in the event of default. S&P is predicting a recovery of 70% to 90% in the event of default, meaning a loss of only 10% to 30%. With the bond currently trading far below the recovery values currently expected by Moody's and S&P, the bondholders are sending a clear message that shareholders should be prepared for further losses.

Disclosure: I am long BTU.

Additional disclosure: I am also long BTU bonds and ANR bonds.