By Taylor Kuykendall

As coal markets have deteriorated across the board, BB&T Capital Markets analyst Mark Levin said the sector has bifurcated into the "haves" and "have-nots" when it comes to the ability to access capital.

Speaking at a recent industry conference, Levin noted that the phenomenon makes sense. Coal sector fundamentals have been falling apart for some time and some of the major players made some risky bets, particularly on the metallurgical coal market. Now that met coal has prolonged a drift toward the market bottom, Levin said, those that took on major debt-financed acquisitions are looking at an "ugly picture" on their balance sheets.

"I think the reality of it is, for many coal companies — they could run out of time. If they don't run out of time, they may make the proactive decisions to restructure some of their balance sheets. … At the end of the day," Levin said, "what this all comes down to is will the markets recover quickly enough before these companies run out of cash or run out of access to capital?"

Levin presented the nearly night and day difference between many of coal companies' balance sheets today compared to 2008 — the year "times were good," "met coal prices were high" and most coal sector "balance sheets were absolutely pristine." Fast forward just a few years and many coal companies are now loaded with debt and struggle to generate enough cash.

"The most practical thing you can do is refurbish your balance sheet when the opportunity presents itself," Levin said. He added that unfortunately, several coal companies failed to do that.

Levin said he believes a commodity cyclical company should probably not have a net debt to EBITDA ratio higher than three to four times. In those terms, it may be easy to see why some in the sector are the have-nots when it comes to being able to access capital.

Coal companies with high exposure to met coal markets like Alpha Natural Resources Inc. and Arch Coal Inc. had a net debt to trailing-12-months EBITDA ratio of 11.2x and 14.9x, respectively, in 2014. The picture is even grimmer for the met coal producer Walter Energy Inc., which Levin noted had a ratio of 195.0x.

Levin said Walter's "access to capital is almost completely closed off" and that the company is burning through its liquidity. While Walter does not have any near-term debt coming due anytime soon, it also does not have much cash on hand.

"Alpha and Arch have liquidity," Levin said at the 23rd Annual Platts Coal Properties and Investment Conference. "They have cash. That [gives] a little bit of breathing room."

Looking at both secured and unsecured bond markets, Levin said it's clear that investors have "very little confidence that these guys are going to get out of this mess." These "have-not" companies looking for capital do not have a lot of levers to pull to escape their debt situation.

"Capital markets are going to be more and more closed. … The people willing to take those risks, really, have gone away," Levin said.

“I think the reality of it is, for many coal companies — they could run out of time.”

 Mark Levin, analyst, BB&T Capital Markets

Issuing common equity is a poor option for many of these companies as their shares routinely trade below $1. Given that dilution is "off the charts," Levin said, the "bang for your buck is de minimis" and comparable to "throwing rocks at a bulldozer."

"If you think about Alpha for example, I mean look, what are you going to do? You can't really issue equity at a dollar," Levin said. "You have to issue it at a discount. … It just doesn't make sense for most companies."

Other options, such as hybrid equity, are available to select coal companies but likely come at too high of a cost for many producers.

"Everything in coal, from an equity perspective, doesn't move the needle or it's so expensive at these share prices — the fundamentals as bad as they are — it's really, really difficult," Levin said.

High yield investors and banks, Levin said, are also hesitant to invest with many coal companies. One of the few options open to all companies is an accounts receivable securitization, but advance rates tend to be low and interest tends to be high.

Exacerbating the issue is that investors have largely lost their appetites for coal stocks. Levin said the appetite for companies with exposure to met coal has particularly spoiled as met coal's price volatility "scares the living bejesus out of anybody."

"Met makes people really, really nervous from a lending perspective as well it probably should," Levin said. "On the steam side, it's not a whole lot better."

The question many of these companies' management will be forced to ask themselves, Levin said, is whether it is advantageous to restructure now or to hold off.

"What you have are several companies that are going to have to make some really big decisions," Levin said. "In the case of Walter, again from my perspective, I think the decision has already been cast."

Levin said that if any of these companies opt to reorganize, it is likely that it will not be the "ultimate panacea" for met coal's oversupply problem as many mines may continue to operate. He said a big part of the reason the supply issue has drawn out so long is that coal companies were successful in proactively securing cash and liquidity before "the market really fell apart."

On the other hand, Levin said, producers like Alliance Resource Partners LP, CONSOL Energy Inc. and Cloud Peak Energy Inc. kept their balances sheets in "good shape." While for them "life is miserable" in the current market, their balance sheets are "defensible" and make navigating the state of the market much easier. Peabody Energy Corp., he notes, is highly leveraged but still has access to capital, even if it is expensive.

Investors like these companies because of their lower debt ratios but also because of their business models. Levin said that some of the important things investors like to see in coal companies are things like minemouth coal operations, avoidance of the expensive Central Appalachia basin, heavily contracted positions and free cash flow.

Chiza Vita, associate director of commodities at Standard & Poor's Ratings Services, said the rating agency has no positive outlooks for any covered coal companies. About a quarter of the agency's ratings are negative — twice as high as 2014.

The few upgrades, he said, have been M&A-based and not based on organic improvement of a company's fundamentals. Looking toward the future, Vita notes many challenges for coal to improve its ratings, including persistently low natural gas prices, ongoing regulatory challenges and sluggish growth in Europe and Asia. The U.S. EPA's Clean Power Plan is also expected to create headwinds.

"We expect this to be more of a long-term effect," Vita said of the Clean Power Plan.