Broadly speaking, there are two sides to the coal industry: steel-making coal and thermal coal. Walter Energy (WLTGQ) is close to a pure-play on the steel side, and Cloud Peak Energy (CLD) is a pure play on the thermal side. Recent debt issuances by both companies put actual numbers on the divergent outlook for each firm.
Debt to survive
Metallurgical coal, accounts for roughly 85% of Walter Energy's business. As that market goes, so goes Walter's performance. Right now, neither met coal nor Walter are doing very well.
Last year, the company lost nearly $6 a share. That was actually an improvement over the almost $17 a share loss in 2012. Both years included large write-offs because of falling metallurgical coal prices. The biggest problem for Walter is a large acquisition it made at the peak of the met market that left the company with overvalued assets. Now, after the write offs, it's just saddled with the debt taken on in the deal. Long-term debt makes up about 80% of the company's capital structure.
Walter is making moves to ensure its survival. For example, it recently announced more mine closures. It's also pushed out its debt maturities to help ensure it survives to fight another day. That's a good decision, but it came with a price. Walter issued $200 million of bonds at an interest rate of 9.5% and $350 million with interest rates of 10% and 11%.
The latter included a payment in kind provision that allows Walter to pay bond holders with more debt if it can't, or chooses not to, come up with cash. Again, this was a good call to ensure survival but an added feature that increases ongoing costs. All told, Walter Energy's interest expense went up by around $30 million a year.
The other side of the debt coin
The fact that Walter Energy is paying up for debt when interest rates remain near historic lows is a huge statement about its business prospects. Cloud Peak Energy's recent success on the debt front is an equally notable statement, but one with a positive twist.
Cloud Peak recently offered $200 million of debt with interest rates of about 6.4%. It's using the new debt to retire older debt with an interest rate of about 8.3%. During the first quarter conference call, Cloud Peak CFO Michael Barrett estimated that the refinancing would lower "ongoing interest costs by around $12 million per year."
Clearly, the market sees a lot more promise in Cloud Peak's future than it does at Walter. That's not surprising since Powder River Basin coal, Cloud Peak's specialty, appears to be turning a corner.
Cloud Peak CEO Colin Marshall summed the PRB market up this way: "it's recovering to a level [that will] actually make it a sustainable business." However, the company believes it is well positioned to "develop an export business." This is particularly evident in Asia: "Demand continues to be strong as our Asian customers are keen to increase U.S. coal imports to diversify the supply options."
While Cloud Peak lost money in the first quarter, that was partly due to rail delays because of bad weather -- in other words, factors totally out of the company's control. It was the company's first quarterly loss even though the coal market has been moribund for several years.
Reading the tea leaves
Often equity investors pay too little attention to the details offered up in the debt markets. The vastly different outcomes for Walter Energy and Cloud Peak on the bond side speaks volumes about their businesses. Not only that, but Walter's new debt is actually going to make turning a profit harder while the struggling met coal miner works through an industry downturn. Cloud Peak, even though it just posted a quarter of red ink, is poised for better days—something the bond market appears to appreciate.
