Walter Energy's Refinancing Efforts Raise Concerns

Troubled met coal miner Walter Energy (NYSE: WLT  ) recently announced that it has started a process to amend its credit facility in order to increase financial flexibility. Walter Energy is seeking to repay its $407 million term loan A without being obliged to make a repayment to the existing $968 million term loan B. Walter Energy shares lost almost 10% on the day of the news, and more downside is possible as the company continues its fight to stay afloat.

Refinancing will lead to more interest expense
Walter Energy amassed its big debt after the ill-timed purchase of Western Coal back in 2011. The company wanted to gain a bigger share of the market and was ready to put itself in debt in order to do so. Walter Energy's peer, Alpha Natural Resources (NYSE: ANR  ) did the exact same thing with its merger with Massey Energy, which also happened in 2011. Now, both Walter Energy and Alpha Natural Resources have market caps that are significantly lower than the amount of money they spent on the merger and acquisition front.

Walter Energy spent $232.8 million on interest expense in 2013. If Walter Energy is successful in amending its credit facility and refinancing, its interest expense will increase, putting even more pressure on its cash flows. Here's why.

According to Walter Energy's annual report, the weighted average interest rate for term loan A was 5.74%, while it was 6.75% for term loan B. There is no chance that Walter Energy will be able to get similar rates when it goes to the debt market. In its latest bond issue in September 2013, the company got a 9.50% interest rate for $450 million senior notes due 2019. As the situation on the met coal market has not improved, it is likely that the interest rate on Walter Energy's next debt issue will exceed 10%.  

All eyes on liquidity
Walter Energy's debt carries some restricting covenants governing the amount of liquidity that the company must have, as well as the level of capital spending. According to these covenants, the company must have at least $225 million of liquidity and allocate no more than $175 million on capital expenditures annually. 

So far, Walter Energy has been in compliance with those covenants. The company had $587.3 million of liquidity at the end of 2013, which consisted of cash $260.8 million of cash on hand and $326.5 million available under the credit facility.

Walter Energy plans to dedicate less than $150 million on capital spending this year. The company finished last year with negative operating cash flow. Given the deteriorating met coal market conditions, there is a possibility that such result will be repeated this year. However, Walter Energy will stay in the limits of its covenants even if it has to finance its capital spending from the available credit facility.

Bottom line
What the company is doing now is just buying time in hope that met coal market conditions improve. However, Australian met coal producers like BHP Billiton (NYSE: BHP  ) continue to increase production, helped by the weak Australian dollar. This puts additional pressure on prices.

A lot will depend on the interest rates Walter Energy is able to get when it refinances its debt. If these interest rates significantly exceed the rate of the latest bond issue, it could negatively impact Walter Energy's financial position, as well as its shares. The act of refinancing alone is a positive, as it moves debt maturities into the future. However, the company's huge debt will always be in the limelight until met coal prices rebound.

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