Research analysts at B. Riley FBR lowered their price target for SunCoke Energy Inc. and downgraded their recommendation from "buy" to "neutral" due in part to uncertainty about the company's future contracts, according to a Sept. 30 research note.
The firm said it is waiting to see how SunCoke renegotiates its contracts with two customers, set to expire over the next two years.
"While we still believe that [Suncoke] is valued attractively on a number of metrics, we think it is best for investors to wait until there is more certainty in regards to a number of issues," the analysts wrote.
ArcelorMittal's 10-year contract with SunCoke at the latter's Jewell and Haverhill Phase I facilities expires in December 2020, and the steel producer is known to "drive a hard bargain in contract negotiations," according to the note. ArcelorMittal could seek better contract terms, such as reduced pricing and/or shorter duration, given a weakening demand outlook and depressed pricing, the analysts noted.
SunCoke's contract with AK Steel Holding Corp. at its Haverhill Phase II facility expires in December 2021. AK Steel owns the Mountain State Carbon coke-making facility, which it could potentially use to negotiate a better deal by suggesting it might source its coke internally. B. Riley FBR wrote that those concerns are "likely overblown" given that the facility is more than a century old and would require significant investment to convert to furnace coke.
SunCoke also faces "significant counterparty risk" at the Convent Marine Terminal as customers Foresight Energy LP and Murray Energy Corp. could potentially enter a bankruptcy restructuring process in the near future, the analysts noted. If those coal producers file for bankruptcy protection, their take-or-pay contracts with SunCoke would likely be scrutinized in the proceeding, they added. Foresight's second lien bonds are trading at about 25 cents on the dollar, and the company may soon have to restructure as a result.
"Amidst a sharp decline in thermal coal prices, particularly in the seaborne market, Murray Energy is reported to be assessing its restructuring options in consultation with bankruptcy advisers," the analysts wrote.
The companies take-or-pay contracts may be rejected and renegotiated if they pursue bankruptcy proceedings, resulting in lower EBITDA margins for each exported ton, according to the Sept. 30 report. The firm lowered its EBITDA margins per ton at the terminal from about $6 to $5.63 and $4.91 for 2020 and 2021, respectively, and volume forecasts from 9 million tons in 2020 and 10 million tons in 2021 to 8.5 million tons in both years.
SunCoke's efforts to diversify the terminal's business and reduce its reliance on thermal coal is not expected to be "a near-term catalyst," given that only about 1 million tons of its expected 8 million tons of throughput in 2019 is estimated to include products outside of coal.
It is also not clear how management will allocate capital to grow organic investment or acquisition, according to the report. The company wants to reduce its gross debt level to less than 3x EBITDA but may add debt in the coming quarters to fund a growth initiative or acquisition and is already at 3.14x EBITDA, according to the firm's 2019 estimate.
"The uncertainty surrounding management's growth strategy continues to keep some investors on the sidelines, as the company has provided few specifics as to which aspect of the business they're likely to invest in, or whether they may pursue a new business entirely," the analysts wrote.
