Overview -- U.S.-coal miner Foresight Energy LLC plans to add on an additional $110 million to its existing $400 million 9.625% senior notes due 2017. -- We are affirming our 'B' corporate credit rating on Foresight and affirming the 'B' issue rating on the company's upsized senior unsecured notes. At the same time, we are revising our recovery rating to '4' from '3' reflecting higher debt levels. -- The stable outlook reflects our opinion that Foresight's leverage (as adjusted) will fall below 4.5x in 2013 despite the incremental debt and our expectation for weak coal markets during the next year. Rating Action On Oct. 24, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporate credit rating on St. Louis-based Foresight Energy LLC. The rating outlook is stable. At the same time, we affirmed the 'B' issue-level rating (the same as the corporate credit rating) on Foresight's 9.625% senior unsecured notes due 2017. The proposed $110 million add-on to the existing $400 million notes brings the total to $510 million. At the same time, we revised the recovery rating to '4' from '3'. The '4' recovery rating indicates our expectation of average (30% to 50%) recovery for lenders in the event of a payment default. The company intends to use the proceeds from its proposed add-on offering to make a distribution to its owners. Rationale The affirmation and stable outlook reflect our view that despite the additional debt, Foresight's low costs and higher production are likely to keep credit measures consistent with an "aggressive" financial risk profile despite difficult industry conditions. We expect that leverage (as adjusted) will be about 5x in 2012 and fall to about 4x in 2013 and estimate that funds from operations (FFO)-to-debt will be between 10% and 15% in 2012 and approaching 20% in 2013. This assessment assumes that the company's new mines will have costs similar to its Williamson operation (between $20 to $25 cash costs per ton) and that prices average between $40 and $45 per ton through 2013. In our view, this should allow Foresight to generate between $300 million and $350 million in EBITDA on approximately 16 million tons of coal sales in 2012 and about $400 million on 19 million tons of sales in 2013, reflecting production from mines opened in 2012. Pro forma debt at June 30, 2012, was approximately $1.6 billion (adjusted for about $424 million in capitalized minimum royalty and lease payments, and about $13 million in asset retirement obligations). For the 12 months ended June 30, 2012, pro forma debt-to-EBITDA was about 5.2x and FFO-to-total debt about 12%. Although we expect weak domestic coal market conditions and high utility inventories to continue to pressure pricing--which we have reflected in our price assumptions--the additional volumes and the company's low cost structure should allow Foresight to maintain credit metrics that are consistent with the 'B' rating. Risks to these expectations include any combination of lower sales prices and lower-than-expected production levels, which could cause debt-to-EBITDA to remain well above 4x in 2013 and could cause us to revise our view of the credit. The rating also reflects our view that the company has a "vulnerable" business risk profile, which takes into account the challenge of operating its two new mines as efficiently as its existing mine, its lack of operating diversity, and the high fixed cost nature of longwall mining. In addition, the rating reflects currently weak industry conditions and the need to obtain customers and contracts for significant amounts of production from new and planned mines during the next couple of years. Also, the challenges of coal mining, including operating problems, price volatility, transportation bottlenecks, weather-related disruptions, and increasingly stringent environmental and safety regulations, remain key risks. Foresight, a privately owned entity, has a relatively short operating history and has brought two of its four operating mines into production in 2012. The longwall mining method that the company employs is highly capital intensive and has high fixed costs, but it is very efficient when operating near or at full capacity. We estimate Foresight's cash costs to be between $20 and $25 per ton, very low for an underground operation, because of favorable geology and modern equipment. We also estimate that the company will have the capacity to produce 20 million to 25 million tons by the end 2013. The company also has another longwall slated to come into production during the next several years. The concentration of Foresight's reserves and production solely in the Illinois Basin exposes the company to unfavorable regional regulation, local transportation disruptions, and the variability of market demand for the specific coal produced in that region, although the efficiency of the company's current operations somewhat mitigates this risk. In our view, unfavorable domestic electricity markets may make it difficult for the company to obtain favorable longer-term contracts for the bulk of its new production during the next couple of years. The company's location on several rail lines and access to river transportation and export markets expands its potential sales area and helps to alleviate this risk, but, in the short to medium term, Foresight may have to sell less coal and some of it at lower prices than the roughly $40 to $45 per ton currently contemplated. Liquidity We consider liquidity to be "adequate" to meet the company's needs during the construction of the new mines. Our assessment of Foresight's liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources of liquidity, including cash and facility availability, to exceed uses by 1.2x or more over the next 12 to 18 months. -- We expect net sources to remain positive, even if production is lower than expected. -- Compliance with financial covenants could survive a 15% drop in EBITDA, in our assessment. As of June 30, 2012, the company had about $45 million of cash and $93 million available under its $400 million revolving credit facility due 2014. Currently planned sales volumes should provide about $200 million of cash from operations in 2012 and about $275 million in 2013. In our view, the company should have sufficient resources to fund capital expenditures, which we estimate to be about $200 million per year in 2012 and 2013 as it finishes its major capital investments. The company has minimal near-term maturities until its revolver matures in 2014. The equipment financings amortize at about $24 million per year. Based on our assumptions, we expect the company to have ample cushion under the revolving credit facility covenants(as defined in the credit agreement), which include a leverage test declining to 3.5x by the fourth quarter of 2012, and an interest coverage test of 2.5x. However, if sales and prices fall short of expectations, liquidity could become less than adequate if the company's cushion under the covenants shrinks as the levels become more stringent. Recovery analysis For the complete recovery analysis, see our recovery report on Foresight to be published following this report on RatingsDirect. Outlook The stable outlook reflects our expectation that the company should be able to maintain operating and financial performance that is consistent with the rating during the next couple of years, based on our assumption that it will sell between 15 million and 16 million tons of coal in 2012 and about 19 million tons in 2013 at $40 to $45 per ton while maintaining costs of $20 to $25 per ton. We also believe the company has adequate liquidity to complete the remaining mines without adding significant leverage. We could raise the ratings if coal markets improve and the company is able to meet its outlined plan for sales and production; has developed a customer base with multiyear contracts; and has established a clear sustainable trend of improving credit metrics, specifically debt-to-EBITDA, as adjusted, below 4x and FFO-to-total debt greater than 20%. We could lower the ratings if the company has delays in construction or coal markets deteriorate further, causing the company to have difficulty in finding customers for its coal and average prices to drop below $40 per ton, which could lead to tight liquidity and covenant compliance issues. Related Criteria And Research -- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed Foresight Energy LLC Corporate Credit Rating B/Stable/-- Ratings Affirmed; Recovery Ratings Revised To From Foresight Energy LLC Foresight Energy Corp. Senior Unsecured $510M 9.625% senior notes due 2017 B B Recovery Rating 4 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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