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Arch Coal’s precarious financial situation

Jing Shun Kee

Company overview: Arch Coal Inc. (Part 8 of 9)

(Continued from Part 7)

Arch Coal’s management strategy

As a company that derives almost all of its revenue from the production and sale of coal, it is subjected to many market conditions that are beyond the management’s control. However, there are certain steps that the company could take in order to better position themselves for the coming years.

In turbulent times like a tough coal market, a company with high leverage, low amounts of cash and high production costs would most probably be the first to go under. Despite the management doing what it can to downsize operations and divest the company’s non-core assets, Arch Coal has faced decreasing margins and increased debt over the past few years. Their debt to equity ratio has more than doubled over the past 3 years. Despite this, Arch Coal has once again increased their debt last December by issuing a cash tender offer for their outstanding $600mm in senior notes at 8.75% due in 2016. They also increased their term loan to $1.95 billion, up by $300mm for Term Loan B at 8%.

These moves were both intended to help cushion and fort the company from further financial losses. The company could also potentially use this increased liquidity to reinvest into their infrastructure of their core assets. It is however taking on an extremely huge risk through by undertaking this amount of debt in a weak coal market. The company’s debt to EBITDA has almost quadrupled over the past 3 years, signifying that they are taking in way more debt than they are earning. Despite this, the management has a positive outlook and strongly believes that they are in a position to capitalize on opportunities should the fundamentals improve in time.

While it looks impressive on their balance sheet to have over $1.5 billion in liquidity on hand and it does put them in a good position to face the weak coal market, it must be noted that they have been consistently losing money every quarter and their cash inflows have been falling drastically over the past 3 years. This cash balance would not last very long if they do not starting posting significant profits in the near future.

Their move to divest their non-core assets could be seen as both a positive and a negative. They did manage to raise their cash balance by divesting the underperforming mines and would have been in a far worse condition if the management had not done so. However, the divestures of their underperforming assets did incur large amounts of impairment costs and goodwill payments. This could be seen as poor capital management by the company. Looking at their past acquisition of International Coal Group in 2011 at the peak of coal prices, one can see that the management did not always preach their prudish approach of managing capital. To date, the acquisition has caused them to carry a significant amount of debt, which puts them in a precarious state with the weaker coal market.

Continue to Part 9

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