Can Walter Energy Inc Stave off Its Creditors Much Longer?

Photo courtesy Walter Energy,

The recent bankruptcy at James River Coal has investors in the coal industry slightly worried about debt profiles. Just about every company in the space is grappling with cost of sales, debt, and liquidity issues, but one company in particular, Walter Energy (NYSE: WLT  ) , looks to be in a worse position than others.

This quarter represents a critical crossroads for the company, one that could determine whether it climbs out of its recent funk or not. Let's take a look at why Walter is in worse shape than other financially distressed companies Alpha Natural Resources (NYSE: ANR  ) and Arch Coal (NYSE: ACI  ) , why this quarter is so important, and what the chances are for the company going forward.

The baddest of the bad
Coal companies like the ones mentioned above have all refinanced their debt portfolios over the past couple of years in order to stave off insolvency, and even that is barely enough for these companies to hang on. Alpha, Arch, and Walter have all been forced to rely on more desperate financing measures such as convertible bonds and secured loans -- loans that are backed by the company's assets rather than their ability to generate profits. Even with these last ditch financing efforts, all three are barely scraping together enough cash to cover interest payments.

Company % of loans that are asset backed Total debt/EBITDA EBITDA/Interest Expense
Alpha Natural Resources 19% 39.51x 0.25x
Arch Coal 44% 19.16x 0.55x
Walter Resources 67% 20.3x 0.54x

Source: S&P Capital IQ

At first glance, it would appear that Alpha was in the most dire straights among these three, but with over $900 million in cash and short-term investments on the books, Alpha should be able to manage a little while longer despite its complete inability to cover its interest payments with cash from operations.

What this table doesn't show, though, is that with some of this debt comes certain financial covenants -- and that is where Walter Energy starts to get in trouble. By the end of the second quarter, financial covenants related to its revolving credit facility will start to take effect. If it wants to keep its current revolving credit line, Walter needs to have a total debt-to-EBITDA ratio on its secured senior notes of less than 8 for the trailing twelve months. According to Bloomberg, the company would have not been in compliance with its debt covenants in the first quarter. To meet that goal, it will need to generate about $40 million in EBITDA per quarter for the rest of the year, a pretty hefty task considering that EBITDA for this past quarter was only $26 million and the market for coking coal hasn't exactly improved over the quarter. 

In the event that it cannot meet these financial terms, then the company will see its ability to borrow under its credit line drop by two-thirds, hitting just $100 million. This could also have a significant impact on its ability to refinance again -- Walter has already done so 6 times since the market starting going south in 2011. 

Can it get there?
Walter Energy has made two significant operational changes in order to get in line with these obligations. First, it has completely shuttered all international mining operations and plans to sell one of its export terminals in Alabama for $25 million. The sale of this terminal should be enough to cover any issues for the second quarter, but beyond that is where this get very close. Walter's American operations may be among the lowest cost sources of coking coal in the world and generating profit today, but its other operations are hemorrhaging money.

Operating Region Tons of Coal Produced (Q1 2014, in metric tons) Operating Profit (Q1 2014, in millions)
US  2,220 $5.8
Canada and UK 1,078 ($52.6)

Source: Walter Energy quarterly earnings report

With Walter shuttering these mines, things should become easier. Currently, the company lost $16 million in gross profit from the sale of Canadian coking coal because the cost to pull it from the ground was greater than its selling price. If idling operations equates to a $16 million gain, then third quarter EBITDA would be $42 million, just enough for it to squeak by its financial covenants. That is, of course, if operations were to continue as they currently are and there are no unseen costs or further asset sales. 

Beyond that, the company will need to be able to out-wait other coking coal producers until prices increase. Alpha has already stated that it will scale back its metallurgical coal production here in the U.S., and major foreign coal miners Glencore Xstrata and Vale SA have recently announced they will cut back on coking coal production as well. For Walter Energy's sake, this reduced production will lead to a strong enough uptick in price to help put some of those secured debt issues behind the company.

What a Fool believes
Walter may be in a worse situation than both Alpha and Arch, but based on the recent moves the company has made it should be able to keep its creditors happy. To be fair, though, most of us aren't creditors, we're investors: If the company is struggling to meet its debt obligations, rest assured that there will probably not be much left over for shareholders. If there was a significant uptick in coking coal prices over the next few months, then perhaps the company would be worth revisiting, but as long as Walter is barely covering its debt obligations by the skin of its teeth, it's awfully hard to get excited about this stock.

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