James River Coal JRCC W
February 25, 2006 - 5:52pm EST by
2006 2007
Price: 37.51 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 630 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Company Description
James River Coal Company (“James River” or the Company) mines, processes, and sells bituminous, low sulfur steam and industrial-grade coal in the Southeast region of the United States. The Company operates five subsidiaries in Eastern Kentucky, which encompass 18 mines. It recently expanded into the Illinois Basin by acquiring Triad Mining, which operates 7 mines in Southern Indiana. James River has approximately 1,400 employees and controls an estimated 261 million tons of proven and probable coal reserves. The Company is headquartered in Richmond, VA and currently manages 212,200 acres of land, 97% of which are leased.

Investment Conclusion
James River represents a compelling investment opportunity due to its positioning as a mid-sized CAPP producer and to its expanding presence in the Illinois Basin stemming from their recent acquisition of Triad Mining. James River recently commenced production at two mines that are slated to increase CAPP production by approximately 1.5 million tons per year. The Company is also looking to aggressively add reserves in the Illinois Basin and will release revised guidance in mid-2006 that is expected to significantly add to the scope of their production. Additionally, the Company is facing pressure from shareholders to seek a sale of the Company given management’s underperformance and the Company’s attraction as a sizeable tuck-in acquisition. The Company is facing a March 15th deadline to hire an investment banking firm and redeem their poison pill.

· Company commencement of production at Mine #15 and Commissary position it to significantly expand production in 2006
· Company has 84% of its 2007 CAPP production and 33% of its 2007 Illinois Basin production uncommitted
· Company has rebuffed prior acquisition overtures from a publicly traded competitor
· Increased consumption by utilities of coal from the Illinois Basin due to increased installation of SO2 scrubbers
stemming from the Clean Air Act
· Senior management and employees own approximately 9% of outstanding shares
· Company has a strong union-free workforce and has experienced low employee turnover relative to its peers
· Trading at a discount to its CAPP peers

· As a thin-seam operator, the Company has and can experience future variability in their production due to geological conditions
· Company needs to execute on its stated strategy of increasing its reserve life in the Illinois Basin
· The Company’s management team is not as deep and experienced as their CAPP peers

Company Snapshot
James River emerged from bankruptcy in May 2004, and was listed on the NASDAQ in January 2005. The Company’s stock price appreciated handsomely during the summer of 2005 in tandem with the rest of the sector as investors focused on the Company’s 2007 open tonnage position in CAPP. The stock has traded off significantly in recent months as the Company’s 3rd quarter results missed by a wide margin and the Company released revised guidance for 2006 and 2007 that significantly reduced forecasted earnings. However, we feel that the Company’s revised guidance was extremely conservative to allow management to easily beat their numbers. We feel that the Street is underestimating the Company's 2007 cashflow and earnings potential due to the Company's previous earnings misses. Additionally, we feel that as the Company’s growth projects come on line, the Company's cost structure will significantly improve.

Company highlights include:

Capex Expansion Focused on Economic Growth Projects
James River recently announced capital improvement projects that will increase the yield of mined coal through various enhancements to its existing 7 preparation plants. Typically, coal is transported from the mine-mouth to the prep plants, where it is washed and sometimes blended with differing quality coal, before the final product is shipped out to the consumer. The projects are concentrated in the screening and separation areas of the plants and are expected to increase yields by 1-2%, or 200,000 to 400,000 tons annually. The Company currently expects these projects to require total funds of $9 - $11 million. All projects are expected to be completed by early second quarter 2006.

CAPP Expansion
James River recently announced a number of growth projects that are slated to be completed in the second half of 2006. These projects are forecasted to increase the Company’s CAPP production to approximately 11.8 million to 12.4 million tons in 2007 and 12.3 million to 12.8 million tons in 2008.

Non-Unionized Labor Force
James River’s employee base of approximately 1,400 personnel is 100% union free. This is clearly a benefit with respect to controlling wages and managing production crews, thereby increasing productivity. Despite industry wide difficulty in securing labor, James River has posted net turnover of approximately 13% versus 35 – 40% for its peers.


The chart below highlights the upside in cashflow that James River is set to realize as the Company increases their CAPP production, continues the integration of Triad Mining, and most importantly contracts their 2007 CAPP and Illinois Basin production. Our assumptions assume 12.1 million tons of production out of the CAPP region in 2007, representing the midpoint of the Company’s 11.8 – 12.4 million ton guidance and flat production of 3.5 million tons out of the Illinois Basin. The Company will be releasing revised guidance in mid-2006 and is expected to increase the scope of their production in the Illinois Basin adding further potential upside. We are forecasting price realizations within a range of $53 - $55 and $32.50 -$34 per ton for James River’s open tonnage out of the CAPP and Illinois Basin regions respectively. There may be further upside to the Company’s CAPP price realizations as most of the Company’s coal is low-sulfur and should garner an SO2 premium. The Company also has approximately 1.2 million tons of unpriced stoker coal which we are forecasting to garner price realizations in the range of $72 - $74 a ton. Additional assumptions include expected cash costs of $39.00 per ton in Central Appalachia, $23.50 in the Illinois Basin, a $2.00 per ton diesel surcharge in the Illinois Basin, and 16.79 million shares outstanding.

Under the assumptions previously stated, James River is expected to generate estimated 2007 EBITDA within a range of $177.8 - $202.2 million. At a current market capitalization of $630 million and with net debt of $126.6 million, James River currently has an enterprise value of approximately $757 million implying that it is currently trading within a range of 3.7x -4.2x 2007 Enterprise Value / EBITDA. This valuation represents a very significant discount to International Coal Group’s 2007E EV/ EBITDA valuation and a discount to Massey Energy’s and Alpha Natural Resources 2007E EV / EBITDA valuation. We feel that competitors will find James River to be an attractive acquisition candidate due to their strong relationships with their customers (mainly Georgia Power), a production base that will be materially expanded via a number of growth projects that will soon come online and we feel that the management team will be motivated to sell given their significant holdings. There a number of interested publicly traded producers that would have interest in acquiring James River at a premum to the current stock price. Additionally, we feel that there are also a number of privately-held producers that are interested in pursuing a transaction with James River to access the public equity markets.


- Rapidly growing production profile
- Trading at a discount to CAPP peers
- Company facing shareholder pressure to pursue strategic alternatives
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