Rating Action: Moody's downgrades Arch Resources' CFR to B1; outlook negative
Global Credit Research - 07 Aug 2020
New York, August 07, 2020 -- Moody's Investors Service, ("Moody's") downgraded Arch Resources, Inc.'s ("Arch") Corporate Family Rating ("CFR") to B1 from Ba3 and senior secured ratings to B1 from Ba3. The rating outlook is negative
"Arch is committed to completing the Leer South project on schedule. Given the margin compression and diminished expected cash flow generation following the global outbreaks of coronavirus, Moody's expects that the company will have much higher net debt balances when the project is completed," said Ben Nelson, Moody's Vice President -- Senior Credit Officer and lead analyst for Arch Resources, Inc.
..Issuer: Arch Resources, Inc.
.... Corporate Family Rating, Downgraded to B1 from Ba3
.... Probability of Default Rating, Downgraded to B1-PD from Ba3-PD
....Senior Secured Bank Credit Facility, Downgraded to B1 (LGD4) from Ba3 (LGD4)
..Issuer: West Virginia Economic Development Authority
....Senior Secured Revenue Bonds, Downgraded to B1 (LGD4) from Ba3 (LGD4)
..Issuer: Arch Resources, Inc.
....Outlook, Changed To Negative From Stable
Moody's expects a very challenging year for the coal industry in 2020, and, with resurgent coronavirus infection rates in certain regions which limit the pace of improvement in end market demand, an extension of those challenges is expected into 2021. Domestic demand for thermal coal, especially in the Powder River Basin region, is constrained by reduced demand for coal for power generation and high inventory levels. Moody's believes that this region will remain in an oversupplied position well into 2021. Domestic and international demand for metallurgical coal is limited by a slow recovery in the steel industry. Moody's believes capacity reduction has not kept pace with the reduction in demand such that there is no near-term catalyst for substantive and sustained price improvement in metallurgical coal.
Moody's downgraded the company's rating to reflect expected weakening in credit metrics. Based on export metallurgical coal pricing moving toward the midpoint of our range of $100-160 per metric ton (CFR Jingtang) in 2021, Moody's expects that the company's EBITDA will fall below $100 million in 2020 and improve into the range of $125-175 million in 2021. The company's debt balance is increasing meaningfully to fund the Leer South project in an environment of compressed earnings and cash flow generation. Management indicated on the second quarter earnings call that it will pursue additional financing to complete the project on time in the third quarter of 2021. Moody's expects the company will burn cash and adjusted financial leverage will increase toward 10x by the end of 2020. Credit metrics will remain stronger on a net debt basis and could improve meaningfully if metallurgical coal prices move back toward the mid-point of our medium-term sensitivity range. However, the previous rating assumed that the company would fund Leer South using mostly internally-generated cash flow and, therefore, it would maintain little or no net debt. Arch reported $350 million of debt and $132 million of net debt at 30 June 2020, up from $22 million of net debt at 31 December 2019.
Moody's believes that investor concerns about the coal industry's ESG profile are intensifying and coal producers will be increasingly challenged by access to capital issues in the early 2020s. An increasing portion of the global investment community is reducing or eliminating exposure to the coal industry with greater emphasis on moving away from thermal coal. The aggregate impact on the credit quality of the coal industry is that debt capital will become more expensive over this horizon, particularly in the public bond markets, and other business requirements, such as surety bonds, will together lead to much more focus on individual coal producers' ability to fund their operations and articulate clearly their approach to addressing environmental, social, and governance considerations.
The B1 CFR reflects a diverse platform of eight coal mining assets in the United States capable of strong cash flow generation. Conservative financial policies, including low debt levels and good liquidity, have helped the company withstand difficult industry conditions. Operational risk is a constraint, with meaningful concentration of earnings and cash flow at two specific mining sites: Black Thunder thermal coal mine in the Powder River Basin and Leer mining complex in Northern Appalachia. Credit quality is constrained more significantly by the inherent volatility of the global metallurgical coal industry, ongoing secular decline in the US thermal coal industry, and ESG factors. The rating also takes into consideration that some mining assets have less favorable operating prospects in the coming years and, therefore, could be subject to more significant reclamation-related spending over the rating horizon.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The SGL-2 reflects our expectation for good liquidity to support operations over the next 12-18 months. Moody's expects that the company will burn cash in 2020 due to heavy expansionary capital spending on the Leer South mine project. The primary source of liquidity beyond internally-generated free cash flow is the company's cash balance combined with modest availability under an accounts receivables securitization facility and an unrated inventory-based revolving credit facility. Arch reported $86 million of availability under these facilities, and, combined with balance sheet cash and cash equivalents of $217 million, had more than $300 million of available liquidity at 30 June 2020. The SGL rating could be downgraded to SGL-3 if available liquidity falls below $250 million.
Environmental, social, and governance factors are important factors influencing Arch's credit quality. The company is exposed to ESG issues typical for a company in the coal mining industry, including increasing global demand for renewable energy that is detrimental to demand for thermal coal, especially in the United States and Western Europe. From an environmental perspective, the coal mining sector is also viewed as: (i) very high risk for air pollution and carbon regulations; (ii) high risk for soil and water pollution, land use restrictions, and natural and man-made hazards; and (iii) moderate risk for water shortages. Social issues include factors such as community relations, operational track record, and health and safety issues associated with coal mining such as black lung disease. Through capital investment in the Leer South project, Arch Resources has been reducing exposure to thermal coal, which carries greater ESG-related risks, and increasing exposure to metallurgical coal, which carries lower ESG-related risks. Arch Resources sold its last thermal coal mine in Appalachia in December 2019 -- a surface mine called Coal-Mac -- and announced the intention to put its thermal coal mines in Colorado and the Powder River Basin region into a joint venture operated by Peabody Energy in June 2019. Governance-related risks are representative of a publicly traded coal company with an ongoing emphasis on maintaining balance sheet cash and good liquidity. However, Arch returned more than $900 million of cash to shareholders since late 2017 and the decision to increase debt levels to complete the Leer South project is deemed as financially aggressive.
The negative outlook reflects the risks and potential acceleration of cash burn associated with pursuing the Leer South project during a period of compressed earnings and cash flow generation due to weak industry conditions. Stabilizing the outlook would require improved industry conditions (including evident firming of metallurgical coal pricing) and stronger expected cash flow generation. Moody's could downgrade the rating with further weakness or lack of recovery in metallurgical coal pricing, expectations for available liquidity to fall below $200 million, or any meaningful operational issues at the company's Black Thunder or Leer mines. Moody's could upgrade the rating with expectations for free cash flow generation above $100 million, evident progress toward returning to little or no net debt, and financial policies consistent that support maintaining this debt position in the medium-to-long term.
Arch Coal is one of the largest coal producers in the United States. The company has two mining complexes in the Powder River Basin, four mining complexes in Appalachia, and two more mines in Illinois and Colorado. The company generated about $2.3 billion of revenue in 2019.
The principal methodology used in these ratings was Mining published in September 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1089739. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
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These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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Benjamin Nelson VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Glenn B. Eckert Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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