Coal Bankruptcy Fears Stoked, but China Risk Is Bigger (Update 1)

"A lot of balance sheets are more stressed," concedes Rollyson, especially since Alpha Natural Resources and Arch Coal made recent large acquisitions. However, in spite of a weak earnings outlook and high leverage ratios, Rollyson notes that many struggling players have pushed debt maturities past 2012 and 2013 through refinancing. "If you look at the group as a whole, most of these guys don't have meaningful debt due until 2015," says Rollyson.

Rollyson even sees a silver lining for James River -- the company he too highlights as the one with the most bankruptcy risk in the sector: "I suspect they have more staying power than people think."

Following Patriot Coal's July 9 bankruptcy filing, BMO Capital Markets analyst Meredith Bandy cut the ratings of many coal sector players, while highlighting that not all operators and basins can't be judged equally.

In fact, as analysts expect thermal coal to rebound, stock performance will be dependent on the basins to which thermal coal players are exposed.

"The Powder River Basin, with some of the largest surface mines in the world, has economies of scale to compete with natural gas below US$3.00/mmBtu," noted Bandy in a July 16 note that highlighted Cloud Peak, Peabody Energy and Teck Resources as thermal coal-exposed players with the balance sheets, margins and valuations to withstand sector headwinds.

"The Appalachian basin is an aging basin facing rising strip ratios, deeper and thinner seam mines and a rising cost structure. Appalachia needs above US$4.00/mmBtu natural gas prices to compete," wrote Bandy, who downgraded regional giants like Arch Coal and Alpha Natural Resources to underperform on falling margins and stretched balance sheets. "Expected closures in Appalachia may also make servicing debt increasingly difficult," Bandy cautioned.

In addition to natural gas switching by utilities, thermal coal miners are struggling with new emissions-based regulations, which alongside better economics for natural gas led to the lowest use of coal-based energy since 1988, according to first quarter Energy Information Administration data. It was this factor, in addition to a concentration to uneconomic coal basins in Appalachia, which drove Patriot Coal into bankruptcy.

In announcing its bankruptcy, Patriot Coal CEO Irl Engelhardt characterized those challenges as part of an industry-wide transformation. "The coal industry is undergoing a major transformation and Patriot's existing capital structure prevents it from making the necessary adjustments to achieve long-term success," said Engelhardt in a statement explaining the bankruptcy filing.