We first wrote about James River Coal (JRCC) in mid-April and assessed its chances of bankruptcy based on conditions at that point. The conclusion was that James River Coal's future was mostly dependent on the price of metallurgical coal. A moderate to strong recovery in metallurgical coal prices would likely make the shares worth several times the $1.53 per share price that it traded at then. However, if the price of metallurgical coal remained flat, then James River Coal would face significant bankruptcy risk in 2014.
Developments in metallurgical coal pricing since that article have increased James River Coal's bankruptcy risk, although management appears to be doing an excellent job in minimizing expenditures. If the metallurgical coal market continues to struggle for much longer, cost management will not be enough, and it will be necessary to seek out additional funding, which could be extremely challenging for James River Coal to secure.
In advance of James River Coal's Q2 FY2013 earnings report, we are going to go through an updated look at its bankruptcy risk.
Metallurgical Coal Pricing
The metallurgical coal market has had a tough run of things recently. Signs of recovery in early 2013 have given way to further price declines over the last few months, with spot prices dropping below September 2012 lows and benchmark pricing for Q3 being settled at the lowest level since 2009.
Here's a look at the average price that James River Coal managed to get for its metallurgical coal recently. Given the deterioration in the market during Q2 and the benchmark pricing settlement for Q3. James River Coal is likely to get pricing similar to Q1 FY2013 levels at best during those two quarters.
Period | Q1 FY2012 | Q2 FY2012 | Q3 FY2012 | Q4 FY2012 | FY 2012 | Q1 FY2013 |
Met Coal Revenue Per Ton | $141.72 | $128.85 | $114.30 | $107.33 | $121.54 | $91.35 |
Thermal Coal Pricing
As mentioned in the previous article, James River Coal has committed and priced its thermal coal production for 2013. As for 2014, it has only priced and/or committed a small volume of thermal coal, as it is waiting for the thermal coal market to recover. The thermal coal market was showing signs of recovering earlier in the year, but has recently declined again as natural gas prices retreated below the $4 per BTU mark. We probably will not see any major movements in the price of thermal coal until the late fall/winter, when cold weather may cause substantial drawdowns of natural gas inventory, increasing the price of natural gas, and creating more demand for thermal coal.
However, the bulk of James River Coal's thermal coal is CAPP coal, which is only said to be competitive with natural gas if natural gas prices reach the $4.50 to $5.00 per BTU mark. Current 2014 contract prices for CAPP coal are well below the $80+ per ton prices that James River Coal is achieving for 2013, and it will likely require an extremely cold winter for natural gas to consistently stay above the $4.50 mark. The last time pricing reached above $4.50 for consecutive months was back in early 2010. It is therefore unlikely that James River Coal will be able to achieve 2014 thermal coal pricing that is above 2013 levels.
Projected Liquidity After Q3
We are going to assume that James River Coal's EBITDA is essentially zero during Q2 and Q3. This is similar to the $581k adjusted EBITD! A in Q1 s! ince James River Coal's thermal coal pricing is essentially set for 2013, and metallurgical coal pricing has gone down since Q1.
As for capital expenditures, James River Coal's earlier guidance was for $70 million in FY2013. It reported $7.7 million in capital expenditures during Q1 FY2013, and suggested on that conference call that capital expenditures during future quarters would be somewhere between Q1 FY2013's figure and the $15.1 million in Q4 FY2012. Averaging those two out gives us $11.4 million per quarter.
Cash interest on its long term debt and fees for letters of credit was estimated by James River Coal to come out to around $38 million in 2013. Its debt exchange in May appears to have increased interest expenses slightly, so we are estimating the interest and revolver costs to reduce cash by around $20.8 million over the next two quarters.
The result is that projected liquidity at the end of Q3 will be around $63.6 million without factoring in potential changes to inventory levels, accounts receivables, and accounts payable.
All Figures in $ Millions | |
Beginning of Q2 FY13 Liquidity | $107.2 |
EBITDA | $0.00 |
Capital Expenditures | $22.8 |
Interest Expense & Revolver Cost | $20.8 |
Projected Liquidity At End of Q3 FY13 | $63.6 |
Scenario 1: No Recovery in Metallurgical Coal Prices Until 2014
Under this scenario, there is no recovery in met! allurgica! l coal prices until 2014. Starting in 2014, metallurgical coal prices increase by $5 per ton per quarter, regaining Q4 FY2012 levels by Q3 FY2014. Each $5 per ton increase in metallurgical coal prices will result in a $4 million improvement in EBITDA per quarter based on 1 million tons sold per quarter and an increase in cost of $1 per ton due to increased cost of purchased coal. In this scenario James River Coal will keep burning cash, as it needs to get around $119 per ton for its metallurgical coal in order for its entire operations to be cash neutral. This assumes that thermal coal prices recover to 2013 contract levels.
In this situation, James River Coal is likely to run out of liquidity at the end of Q3 FY14.
All Figures in $ Millions | Q4 FY13 | Q1 FY14 | Q2 FY14 | Q3 FY14 |
Beginning of Quarter Liquidity | $63.6 | $41.8 | $24.0 | $10.2 |
EBITDA | $0.0 | $4.0 | $8.0 | $12.0 |
Capital Expenditures | $11.4 | $11.4 | $11.4 | $11.4 |
Interest Expense & Revolver Cost | $10.4 | $10.4 | $10.4 | $10.4 |
Projected End of Quarter Liquidity | $41.8 | $24.0 | $10.2 | $0.4 |
Scenario 2: Recovery in Metallurgical Coal Prices Starting In Q4
Under this scenario, metallurgical coal prices start recovering in Q4, increasing by $5 per ton per quarter. After 5 quarters at this rate of increase, James River Coal will reach a cash neutral position. However, this cuts its margin of safety to a very low level, as liquidity is projected to bottom out at around $14 million at the end of 2014. Any hitch in the metallurgical coal market recovery or thermal coal market recovery or problems with its operations could result in them running out of money.
$11.4
All Figures in $ Millions | Q4 FY13 | Q1 FY14 | Q2 FY14 | Q3 FY14 | Q4 FY14 |
Beginning of Quarter Liquidity | $63.6 | $45.8 | $32.0 | $22.2 | $16.4 |
EBITDA | $4.0 | $8.0 | $12.0 | $16.0 | $20.0 |
Capital Expenditures | $11.4 | $11.4 | $11.4 | $11.4 | |
Interest Expense & Revolver Cost | $10.4 | $10.4 | $10.4 | $10.4 | $10.4 |
Projected End of Quarter Liquidity | $45.8 | $32.0 | $22.2 | $16.4 | $14.6 |
Scenario 3: Strong Recovery in Metallurgical Coal Prices Starting In Q4
Under this scenario, metallurgical coal prices start recovering in Q4, increasing by $10 per ton per quarter, and reaching a high of $131 per ton after four quarters of recovery. This is a strong and quick recovery that results in liquidity bottoming out at around $44 million. In such a scenario, James River Coal is in good shape through 2014 and can turn its attention to dealing with 2015 debt maturities, which are at manageable levels now.
All Figures in $ Millions | Q4 FY13 | Q1 FY14 | Q2 FY14 | Q3 FY14 | Q4 FY14 |
Beginning of Quarter Liquidity | $63.6 | $49.8 | $44.0 | $46.2 | $56.4 |
! EBITDA | $8.0 | $16.0 | $24.0 | $32.0 | $32.0 |
Capital Expenditures | $11.4 | $11.4 | $11.4 | $11.4 | $11.4 |
Interest Expense & Revolver Cost | $10.4 | $10.4 | $10.4 | $10.4 | $10.4 |
Projected End of Quarter Liquidity | $49.8 | $44.0 | $46.2 | $56.4 | $66.6 |
Conclusion
Due to a prolonged slump in the metallurgical coal market, James River Coal's risk of bankruptcy during 2014 has increased substantially. While the metallurgical coal market has shown signs of stabilizing again recently, there needs to be a sustained and strong recovery starting very soon for James River Coal to make it into 2015 without additional funding.
At a minimum there needs to be a sustained 10+% improvement in metallurgical coal prices within the next 2-3 months for James River Coal to be in better shape. As well as that, 2014 average pricing for metallurgical coal needs to be at least 20% higher than current levels.
If the improvement in the next 2-3 months does not occur, James River Coal will likely be at the mercy of requiring extreme weather events (severe flooding in Australian coal mines or near record cold weather) to make it through 2014 without re! quiring a! dditional funding. Costs have been already cut to near minimums, so the only other measures that could buy the company additional time to wait out a market recovery are to draw down inventory and accounts receivables. This may extend the ability to wait out a market recovery by a couple quarters. On the other hand, a warm start to winter could quickly wipe out that remaining safety buffer.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JRCC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
Additional disclosure: I am waiting until after the Q2 earnings report to decide if I should take a position in JRCC. I may take a speculative long position in JRCC if the price declines after earnings and cost cutting and 2014 thermal coal pricing and volume commitments exceed my expectations. Close to the $1.50 level may be attractive in that circumstance. If there is a pop similar to Q1's 29% increase after earnings it may lead me to take a short position if they haven't entered into contracts for a reasonable amount of 2014 thermal coal deliveries at a price close to 2013's.
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