OREANDA-NEWS. Fitch Ratings has downgraded Peabody Energy Corporation's (Peabody, NYSE: BTU) Issuer Default Rating (IDR) and senior unsecured notes to 'B' from 'BB-', and assigned a 'BB-/RR2' rating to the proposed \$1 billion second lien notes. Net proceeds of the notes are intended to be used to fund the tender offer for the \$650 million senior unsecured notes due 2016 and for general corporate purposes.

Approximately \$7.3 billion in face amount of debt, including the \$650 million of notes tendered for, is affected by today's rating actions.

A complete list of rating actions follows at the end of this release.

The Rating Outlook has been revised to Stable from Negative. Fitch believes the coal markets are at or near the bottom of the cycle and should show slow recovery.

KEY RATINGS DRIVERS
Peabody's credit ratings reflect its large, well-diversified operations, good control of low-cost production, exposure to high-growth markets in Asia, top-line visibility in the domestic market, strong liquidity, and high financial leverage. Weakness in pricing for the company's Australian coals, partially offset by cost reductions and currency moves, coupled with high interest expense following the 2011 leveraged acquisition of Macarthur Coal Limited, has resulted in low earnings, cash flows and debt repayment. The downgrade is the result of Fitch's expectations that leverage could be above 7x through 2016 before declining.

Company Profile:
Peabody is the largest global private sector coal company, with 26 active mining operations producing primarily low-sulfur thermal coal from the Powder River Basin (PRB; 2014, 142 million tons sold), high heat thermal coal from the Illinois Basin (IB; 2014, 25 million tons sold), and thermal and metallurgical (met) coal in Australia primarily for the Pacific Basin seaborne markets (2014, met 18 million tons sold, steam 20 million tons sold). As of Dec. 31, 2014, proven and probable reserves were 7.6 billion tons, down from 8.3 billion tons at Dec. 31, 2013.

Operating Environment:
The industry is heavily regulated as to safety and the environment. The company has a good compliance history. Shipments can be disrupted by geology, weather, or transportation events beyond management control.

Industry Risk:
Steam coal demand in the U.S. is recovering, supply has been disciplined, stocks are falling and prices should improve going forward. Growth is constrained by the availability and price of natural gas. Globally, both the met and steam coal markets are in excess supply and prices are weak. Coal producers have been running for cash with a focus on reducing costs, which has delayed price recovery. In particular, Fitch believes the hard coking coal benchmark price could average below \$135/tonne (t) and the Newcastle steam coal benchmark average below \$75/t beyond 2015. The industry is consolidating, which should benefit supply/demand dynamics longer term.

Financial Flexibility:
At Dec. 31, 2014, cash and equivalents were \$298 million, of which, \$195 million was held by U.S. entities. The \$1.65 billion secured revolver due September 2018 was utilized only for letters of credit (LOCs), in the amount of \$114.9, million and the \$275 million off-balance sheet asset securitization facility due April 2016 was drawn in the amount of \$30 million and had outstanding LOCs in the amount of \$15 million. Pro forma for the \$1 billion second lien issuance, liquidity was \$2.3 billion. Pro forma scheduled maturities of long-term debt over the next five years are estimated at \$21 million in 2015, \$19 million in 2016, \$13 million in 2017, \$1.5 billion in 2018 and \$12 million in 2019.

Amendment to the Credit Agreement:
On Feb. 5, 2015, Peabody obtained an amendment to its credit agreement intended to improve availability under its revolver and allow secured refinancing of upcoming bond maturities. The facility now has a minimum interest coverage covenant of 1x through maturity and a net first lien leverage maximum of 4.5x through maturity. In addition, second lien financings are unlimited.

Collateral Structure:
In exchange for the amendment, the revolver and term loan gained additional security including a first lien on substantially all domestic collateral. This is in addition to the original security of the pledge of 65% of equity in the holding company for Australian operations and 100% of the shares in the entity that holds the intercompany receivable from Australian operations. Fitch notes that first priority interests in security over real property interests located in the U.S. with gross book value greater than 1% of consolidated net tangible assets (CTN, or substantially total assets less intangibles less current liabilities) is capped at 15% of CTN less \$50 million. The cap is currently estimated at \$1.7 billion. This increase in collateral drove the affirmation of the senior secured credit facilities at 'BB' despite downgrades across the rest of the capital structure.

Recovery:
Despite the cap on real property interests, the bank facilities have a priority interest in cash flows by virtue of pledged shares and Fitch expects outstanding recovery ('RR1') of the first lien debt in the event of a default. The second lien notes, anticipated to be \$1 billion, are expected to have superior recovery ('RR2'), the senior unsecured notes are expected to have average recovery ('RR4') and the subordinated notes are expected to have poor recovery ('RR6') in the event of default.

Expectations:
Fitch believes operating EBITDA could drop below \$500 million for 2015 on low average metallurgical coal prices and Asia Pacific steam coal prices. Under the same assumptions, negative free cash flows could be as much as \$450 million. Peabody guides to 2015 capital expenditure of \$180 million to \$200 million before coal lease expenditures (\$280 million in 2015). Currently, cash interest expense runs about \$400 million and dividends are about \$3 million, annually. Fitch believes pro forma cash interest expense could be more than \$450 million depending on the size of the issue and the interest rate. Management believes the 2014 capital spending level can be maintained through 2016.

Key Assumptions:
--2015 benchmark hard coking coal and Newcastle prices of \$120/t and \$65/t, respectively;
--Production in the Western U.S. at 3 million tons below guidance;
--Other production, dividends and capital spending at guidance;
--New debt up to \$1 billion;
--2015 aggregate cash operating cost improvement of 4% over 2014;
--No asset sale proceeds.

Capital Structure:
Total debt with equity credit of \$6 billion compares to preliminary 2014 operating EBITDA of \$767 million at 7.8x. Fitch expects scant debt reduction in advance of 2017 absent asset sales. Total debt could increase to as much as \$6.3 billion with the second lien issue. Fitch expects leverage could be above 7x through 2016 before declining.

Ratings Sensitivities:

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Expectations of operating EBITDA less than \$750 million in 2016;
--Expectations of total debt/EBITDA greater than 7x in 2017;
--Expectations of funds from operations fixed charges coverage sustainably below 1.5x

Positive: Future developments that may lead to a positive rating action include:

--Rationalization of excess supply in the seaborne metallurgical and steam coal markets resulting in improved prices;
--Expectations of total debt/EBITDA sustainably less than 4.5x and positive free cash flow.

Fitch has taken the following rating actions:

--IDR downgraded to 'B' from 'BB-';
--Senior unsecured notes downgraded to 'B/RR4' from 'BB-';
--Convertible junior subordinated debentures downgraded to 'CCC+/RR6' from 'B';
--Senior secured revolving credit and terms loan affirmed and RR assigned at 'BB/RR1'.

In addition, Fitch has assigned the following rating:

--Prospective senior secured second lien notes rated 'BB-/RR2'.