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Here's a Good Guess of Where the Next Coal Mine Collapse Will Take Place

James River Coal (NASDAQOTH: JRCCQ  ) just missed a debt payment, effectively defaulting on its IOUs. Although Walter Energy (NASDAQOTH: WLTGQ  ) isn't anywhere near that, it's issuing new debt to pay off old debt. While it's gaining near-term flexibility, the trends aren't in Walter's favor for avoiding a James River-like outcome.

More than new for old
Companies often issue new debt to pay off old debt. Recently, that's mostly been a way to lower interest rates. However, that's not the case for Walter. It just issued $550 million in debt to pay off a term loan at the cost of increasing its debt payments by over $30 million annually.

It's clearly bad for Walter to increase interest expense in a tough coal market, but that's not the only problem here. The company used PIK Toggle notes for $350 million of this debt issuance. PIK stands for "Payment in Kind". Essentially, instead of paying interest, Walter can choose to issue debt holders more debt. No wonder it had to pay interest rates of 11% on that piece of the issuance.

The company isn't just rolling over debt or looking for added near-term flexibility. It's looking to safeguard against a time when it can't afford to pay interest. That's not a good sign.

Some good industry news
To be sure, there have been positive signs coming out of the coal industry. For example, Alliance Resource Partners (NASDAQ: ARLP  ) posted yet another year of record results in 2013 and is fully expecting 2014 to be even better. This is because the miner is focused almost exclusively on the Illinois coal basin (ILB).

(Source: US House Subcommittee on Energy and Natural Resources)

Despite coal's malaise, the ILB has continued to see robust demand and production. For example, according to the U.S. Energy Information Administration (EIA) coal production in the United States fell by 0.4% last year but ILB coal production was up a robust 5%. The EIA attributes that to utilities switching to ILB coal in lieu of coal from other basins.

And while Powder River Basin (PRB) coal production was down 2% last year, utility stockpiles are below their five year average. That will be a benefit to Cloud Peak Energy (NYSE: CLD  ) , which mines exclusively in the PRB. CEO Colin Marshall ended the company's fourth quarter conference call by saying, "...hopefully the impact of the cold weather will further improve demand and prices."

Based on comments from other big PRB miners and PRB stockpile trends at utilities, it's a solid bet that he'll have good news to report in the first quarter. For example, Arch Coal (NYSE: ACI  ) CEO John Eaves commented during his company's fourth quarter call that, "Some of our customers have raised concerns about potential stockpile shortages if these trends continue."

Eaves and Peabody Energy (NYSE: BTU  ) CEO Gregory Boyce both highlighted spot price increases in the PRB of as much as 40% over their earlier lows. That should lead to some good news for Cloud Peak, Peabody, and Arch. Peabody Energy is also a big player in the ILB, so it's particularly well positioned in the U.S. thermal market. However, like Arch Coal it also has exposure to the metallurgical coal sector.

The wrong coal
Met coal isn't as far along as U.S. thermal coal in balancing out supply and demand. So despite the positives taking shape, Arch and Peabody will still have to carry around a heavy anchor. That brings the discussion back to Watler—Steel making coal accounts for nearly 90% of Walter's coal output. So, even though you may be seeing some signs of life in the moribund coal industry, Walter won't benefit because met coal prices remain relatively weak.

WLT Chart

WLT data by YCharts

That helps explain why it's looking for increased flexibility. It also explains why the shares have been heading steadily lower since peaking in 2011. It's way too soon to for Walter to throw in the towel, but after a huge price fall, two years of deep red ink, and the new PIK toggle notes, it would be understandable if you decided that Walter wasn't worth the risk.

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Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 04, 2014, at 12:59 PM, justy727 wrote:

    Reuben Brewer,

    Thank you for this article. When you look at the chart for Walter Energy, one can't help but think, "WOW! Is now a great buying opportunity or what!"

    But their refinancing and debt issues are a huge concern. Definitely, worth watching Walter in the next 3-12 months and watch their quarterly results.

    I understood supply/demand metrics and avoided thermal coal until last year, but I'm still not quite sure why met coal is struggling so much?!? My best guess is that China bought so much in 2011 that prices skyrocketed, and so did their stockpiles. Then when the market was producing so much due to prices, they stopped buying and artificially deflated prices.

    I got a lot to learn about this, and would like to hear your thoughts on this.



  • Report this Comment On April 04, 2014, at 1:01 PM, justy727 wrote:


    How do you track thermal and met coal prices?? Is their an agency that tracks the spot market price for coal?

    WTI and Brent crude are trackable, same with Henry Hub for natural gas, but coal.....?


  • Report this Comment On April 07, 2014, at 12:50 PM, dafacai wrote:

    this article looks familiar. is it a repeat? look at articles in Seeking Alpha, if we have more articles like this, i am afraid readers will .....

  • Report this Comment On April 07, 2014, at 11:38 PM, Rdi8000 wrote:

    With MET coal under cash costs of most producers including nearly all the Asia producers, how could production not fall as producers seek to rationalize production along terms of profitability. It has been said the market is oversupplied by 4%. Some producers have already cut (Glencore for example). It seems like it is another boom bust cycle ready to start the boom as producers respond to low prices with cuts and price rises just like late 2010 which was the last time producers were oversupplied and needed to cut. WLT went from $10 to more than $140 last time. What can it do this time with greater than 50% short interest? That portion was left out of the story. Hedge fund sponsors did not want to bring this up.

  • Report this Comment On April 08, 2014, at 7:09 AM, yannismail24 wrote:

    It you go back in 2005 you can clearly see that WLT had a 3.5bil dept and only 137mil cash; a worst case scenario than today. Prices didn't recover until 2008 and WLT didn't go bankrupt. The risk is not as high as some want you to believe.

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Reuben Brewer

Reuben Gregg Brewer believes dividends are a window into a company's soul. He tries to invest in good souls.

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