The Dow Jones U.S. Coal Mining Sector Index has more than doubled so far this year, up 117.6% through July 15, obviously much better than the broader DJ US Total Market Index’s gain of 5.7%. Much of coal’s gains reflect “dead cat bounces” from stocks that trade in the pink sheets. Yet even the sector’s larger cap survivors are up big this year: Westmoreland Coal (WLB) is up 48%; Alliance Resource Partners (ARLP) is up 35%; Cloud Peak Energy (CLD) is up 35%; CONSOL Energy (CNX) is up 34% and CNX Coal Resources (CNXC) is up 22%.
Even with this year’s strong gains, however, the DJ US Coal Index is down more than 80% from its early 2012 highs. (It was down more than 95% at the lows in February, but has since bounced back.)
Despite the more recent gains in coal stock prices, the industry’s recovery took a disappointing turn last week when the Energy Information Administration (EIA) reported that weekly coal production fell by 8% in the week ended July 9 to just 12.9 million tons from 14.1 million tons in the previous week. Before that, weekly production totals had been rising steadily since early April, catching up steadily to prior year figures. In the week ended July 2, weekly production was only 1% behind the comparable prior year. (In early April, production had been running as much as 43% behind last year.)
With last week’s plunge, weekly production fell to 23% behind last year’s total. The decline is somewhat surprising because summer temperatures have been running well above last year, so electric power plants should be running at higher utilization rates. Still, one week does not indicate a trend. No one has decreed that this would be a straight line recovery in coal. Hopefully, this will just be a bump along the road to recovery.
Spot coal prices have fallen steadily throughout this period, even as production has begun to recover. For example, spot prices in the Power River Basin have slid from $9.70 per ton at the beginning of the year to $8.70 per ton in the week ended July 15, according to the EIA (via SNL Energy). Likewise, spot prices in Northern Appalachia fell from $48.35 at the end of 2015 to a low of $42.10 at the end of June, but they have risen to $43.35 in early July. Central Appalachia spot coal slipped from 43.50 to a low of $40.50, but it too is up slightly, to $41.10 in July.
With the hot summer weather and even after adjusting for a modest decline in coal-fired capacity again this year due to the EPA’s MATS rule, demand for coal should be stronger throughout most of the second half of 2016, especially in the fourth quarter (as prior year comparisons get easier). Even so, second quarter results, due out for most companies in the coming weeks, are likely to be dismal.
Alpha Natural Resources (ANR). On July 12, the bankruptcy court confirmed Alpha Natural’s Bankruptcy Plan. From this point forward, the company must formally arrange for its exit financing and complete the necessary documentation on the securities to be distributed in order for the Plan to be declared effective. Barring any unforeseen events, ANR could emerge from bankruptcy in a matter of weeks, which would be a little over one year from the date – August 3, 2015 – that it filed for bankruptcy.
In accordance with the Bankruptcy Plan, the company filed with the court on June 30 a number of exhibits outlining the terms of various securities and agreements that are a part of the Plan. I was surprised at the timing of these disclosures. The Plan and accompanying Disclosure Statement that was sent out to creditors did not include the proposed terms of the various agreements and securities to be issued under the Plan. Those terms were be filed with the court after the voting by creditors was complete but before the Plan was to be confirmed. Creditors had to vote on the Plan without knowing key provisions of it. They therefore had to accept that the company’s estimates of recoveries – 1.5% to 3.0% in the case of unsecured creditors – were correct and that the Plan treated them fairly.
The company and its financial advisors must have created detailed financial models to determine these estimated recoveries. Yet, none of this analysis was included in the disclosure documents. The financial projections included in the Disclosure Statement were rudimentary. They did not, for example, even mention the three classes of preferred stock that were proposed for reorganized ANR and Newco, let alone compute their potential impact on the estimated recoveries for impaired creditors.
I am not a bankruptcy lawyer nor do I have extensive knowledge about the bankruptcy process. Even so, I believe that if the debtor is requiring creditors (who did not participate in the negotiations over the Plan) to vote with incomplete information, the duty for ensuring that the estimated recoveries are reasonable and the overall Plan is fair to creditors falls to the various creditors’ representatives – in this case, for the unsecured bondholders, the Official Committee of Unsecured Creditors.
The Committee did indeed give its support to the Plan and Disclosure Statement. This is surprising to me for many reasons. Here are two: The Plan calls for the issuance of two series of preferred interests in reorganized ANR, one of which, the Series A Preferred, is to be given to First Lien Lenders. But these are not garden variety preferred stocks. The Series A will capture 65% of the distributions to equity shareholders up to $75 million cumulatively and 50% of all distributions thereafter. The term sheet does not indicate whether this preferred is redeemable and if so, at what price. At a minimum, the term sheet for these Preferreds should have been submitted to creditors before the vote, because the Preferreds are material to the estimated recovery value of reorganized ANR, which is to be distributed to second lien and unsecured creditors.
Another reason for my surprise of the Creditor Committee’s support of the Plan is based upon the terms of the warrants that are to be issued to second lien noteholders and unsecured creditors. The formula for determining the strike price on the warrants is based upon the notion that the First Lien Lenders should get all of their money back with interest before the warrants get a dime of intrinsic value. That’s OK in principle, but according to my reading of the term sheet, the value of the Series A Preferred (to be issued by reorganized ANR as described above) is not included in the estimate of recovery to First Lien Lenders. In essence, the First Lien Lenders could get all of their money back with interest (as of the date of the bankruptcy filing) plus the value of the Series A preferred before the junior creditors realize any value from the warrants. That, I believe, is more than they are entitled to. If I am correct in my reading of the documents, it is surprising that the Creditors Committee did not object to the warrant strike price formula. (It should be noted that the terms of the warrants were included in the Disclosure Statement, so creditors had the opportunity to factor this into their voting decisions.)
Despite these and other apparent oversights by the Creditors Committee, the Plan did receive an affirmative vote from all impaired creditor classes. It is possible that the junior creditors believed that it was unlikely that they would be able to get a materially better deal than what the company had proposed. Under the company’s analysis, all creditors with claims junior to the First Lien Lenders would have received nothing in a liquidation. Consequently, junior creditors may have decided that it was better to get something rather than nothing (as they might have received under the cramdown provisions of section 1129(b) of the bankruptcy code).
Nevertheless, the junior creditors are entitled to and should have insisted upon a properly crafted Plan with adequate disclosure documents. Although this Plan and Disclosure Statement did receive court approval, I believe that it was severely deficient in its disclosures and unfair at least with respect to the warrant strike price formula and terms of the Series A preferred. At the very least, all of the exhibits included in the Plan should have been filed with the court before the voting deadline. Under the circumstances, it is not surprising that ANR’s unsecured bonds have fallen from end of May levels around 1.00 to about 0.50 both immediately before and since the Plan vote and confirmation.
Arch Coal (ACIIQ). Earlier this month, Arch agreed to sweeten the pot for general unsecured creditors. In the first Bankruptcy Plan, the company had disclosed that it had made an offer of equity to unsecured creditors (without specifying the amount), but said that its offer had been rejected. In this the third Plan, it has proposed giving them $30 million in cash, 6% of the common stock of the reorganized company and warrants for 12% of the reorganized equity. GSO Partners, which had filed a separate suit related to a failed exchange offer in the second half of 2015, has reportedly settled for $5 million. I will provide a look at the ACI Bankruptcy Plan in a future post.
July 19, 2016
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
(908) 448-2246
incomebuilder@larkresearch.com
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