Why Arch Coal’s debt profile hinges on liquidity

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Debt profile

Just like its peers (KOL), Walter Energy, Inc. (WLT), and Alpha Natural Resources, Inc. (ANR), Arch Coal Inc (ACI) has a considerable amount of debt—$5.1 billion—on its balance sheet. Much of the debt was added in 2012 after the acquisition of International Coal Group, Inc. The debt consists of a $1.9 billion term loan due in 2018, and notes maturing between 2019 and 2021.

Bank of America Corp (BAC) is the lead arranger of the loan. The loan is structured in such a way that the company will have quarterly principal repayments of $4.875 million until 1Q2018, and a final payment of $1.85 billion in May 2018.

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While coupon rates for the notes is in the range of 7% to 9%, the yields traded on the market have gone up from 19% to 37.6%. If yields are more than the coupon offered, notes trade on discount. This is because the market expectations, or yield, are higher than the interest rate, or coupon, offered by the company. Yields take into account the maturity risk, default risk, and other risks associated with the security.

Liquidity

While there are no major repayments coming up until 2018, maintaining liquidity is essential for Arch Coal. This is because it’s been burning cash for the last few quarters and is expected to do so for the next few. The company had total liquidity of $1.25 billion as of June 2014, out of which $989 million was in the form of cash and cash equivalents. How far can available liquidity take the company if the cash burn continues?

Cash burn profile

The company burnt $38 million in operating activities and spent another $81 million on capital expenditures in 2Q2014, taking the free cash outflows to negative $119 million. Also, the company has quarterly principal payments of $4.875 million on the term loan. If the cash burn continues for the next few quarters, the company will exhaust its liquidity in that same time frame.

What does the debt, liquidity, and cash burn means for the company’s credit rating? We’ll see, next.

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