S&P Lowers Outlook on Arch Coal (ACI) to Negative; Potential Downgrade on Met Coal Price Activity

Standard & Poor's Ratings Services said it revised its rating outlook on Arch Coal, Inc. (NYSE: ACI) to negative from stable. At the same time, we affirmed our 'B' corporate credit rating on the company. In addition, we affirmed our 'B' issue-level ratings on the company's senior secured bank facility and term loan B remain, commensurate with a '2' recovery rating and indicating our expectation of substantial (70%-90%) recovery for holders in the event of a payment default. We also affirmed our 'CCC+' rating on the company's senior unsecured notes, two notches below the corporate credit rating and commensurate with the '6' recovery rating, indicating our expectation for negligible (0%-10%) recovery in the event of a default.

The negative outlook reflects the potential for a downgrade if average met coal prices do not improve in line with our expectations of $140 to $160 per ton in the next 12 to 18 months. This would cause Arch to continue burning cash and use liquidity faster than forecast. Downside risks include slower steel production in China, continued weakness in Europe, and excess global met coal supply depressing met coal prices beyond 2015. However, we are expecting these prices to improve under our base case because of significant capacity curtailments that have been announced. We also expect domestic thermal coal markets to improve modestly as utilities replenish depleted stockpiles stemming from the harsher-than-expected 2013/2014 winter--thermal coal prices for Arch's Powder River Basin (PRB) mines are up 6% for 2015 commitments made through the end of July.

"The negative outlook reflects the possibility that global supply and demand conditions for met coal will not support a near-term price recovery, driving Arch to encroach its senior secured leverage covenant in June 2015 and burn more cash than expected," said Standard & Poor's credit analyst Amanda Buckland.

We could lower the rating if the weak met coal environment persists at an average benchmark price less than $140/ton in 2015, causing possible violation of the senior secured leverage covenant. We could also lower the rating if continued cash burn deteriorates liquidity to less than $550 million in cash and revolving credit facility availability, which could occur if average met coal prices remain about $120/ton or less beyond 2015.

An upgrade is not likely in the near term because we expect leverage to remain very high, with debt to EBIDTA above 10x through 2015. We could revise the outlook to stable if we see a sustained recovery in met coal leading to an improvement in cash flow generation and operating performance.

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