James River Coal (NASDAQ: JRCC) just missed a debt payment, effectively defaulting on its IOUs. Although Walter Energy (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 (ARLP -0.33%) 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 (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 (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.
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.
