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Walter Energy (NASDAQOTH: WLTGQ ) is a met coal miner in a tough situation. Met coal prices remain depressed, and the big company's debt weighs on its performance. In its latest refinancing effort, Walter Energy announced the offering of two notes issues: 9.50% senior notes due 2019, and a $350 million offering of PIK (Payment in Kind) toggle 11%/12% notes due 2020.
The use of PIK toggle notes signals difficulties in receiving financing
The first senior notes' interest rate is in line with the one that Walter Energy got in September 2013. Back then, the company issued $450 million senior notes due 2019. However, there is a significant difference in the sum of money that the company could raise from the issue. In present conditions, Walter Energy managed to issue just $200 million of such notes, less than half the sum it got in September. This is a sign that the debt market is unwilling to absorb large quantities of senior notes issued by the company.
As a result, Walter Energy was forced to use PIK toggle notes. The issue of toggle notes means that Walter Energy will be able to defer interest payments on these notes in exchange for increased yield in the future. What's more, Walter Energy's PIK toggle notes are classified as second lien, which means that the holders of those notes will be in the second row of bond creditors should the company default on its debt.
So far, this is the first use of such financial instruments by struggling coal companies. Met coal miners like Alpha Natural Resources (NASDAQOTH: ANRZQ ) or the iron-ore heavy Cliffs Natural Resources (NYSE: CLF ) have not used such vehicles. Although both Alpha Natural Resources and Cliffs Natural Resources are pressured by low prices, their financial condition is far superior to Walter Energy. Alpha Natural Resources got 50% of its revenue from met coal in 2013, while Cliffs Natural Resources got less than 15% of its revenue from met coal last year. These companies have significantly less exposure to met coal than Walter Energy, which is an advantage in current conditions.
Expect further downside
Walter Energy remains in a very vulnerable position. The company needs improvement on the met coal price front, but this does not happen. Walter Energy's next step could be to divest some of its assets in order to boost liquidity. However, this will lead to further deterioration of shareholder value, as the prices for met coal assets are exceptionally low and it is difficult to find a buyer.
Walter Energy is very sensitive to met coal price changes, as it primarily sells its met coal under fixed price supply contracts with pricing terms of three months. Thus, each negative change on the price front will be reflected in the company's cash flow as early as the next quarter. This also opens possibilities for upside should the prices trend higher. However, as the met coal market remains oversupplied and miners are reluctant to cut production, met coal prices are likely to remain under pressure.
Walter Energy's fate is unclear. The debt market demands higher rates for the financing of the company. Increased interest expense will put additional pressure on Walter Energy's operating results. The company must find ways to cut its operating costs further. Otherwise, Walter Energy will continue to report negative quarterly operational cash flows, which could cut the company's access to debt market.
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