Is Walter Energy's Sell-off a Buying Opportunity or the Beginning of the End?

Walter Energy (NYSE: WLT  )  has been one of the worst performers in the troubled coal mining sector. The pure met coal play is down an astonishing 70% year to date. Each month without a recovery in met coal prices puts additional pressure on Walter Energy's business and on its shares. Back in 2011, Walter Energy acquired Western Coal for $3.3 billion. Now, Walter Energy's total capitalization is just $300 million. Is the end near?

Cash is king
In April, Walter Energy decided to idle its Canadian mines. This is a crucial move, and its consequences will be of the utmost importance. Canadian mines were a source of a $52.6 million operating loss in the first quarter, while its U.S. operations scored a $5.9 million operating profit. Thus, Walter Energy should be able to improve its cash flow with the exclusion of its Canadian operations. Otherwise, the company's future would be under question.

Currently, the most important thing for Walter Energy is to service its $2.9 billion debt. While there are no doubts that the company will make all necessary payments this year, the situation for 2015 is less clear. The biggest payment of 2015 is $391.6 million on Walter Energy's 2011 credit agreement. In addition, the company has several note payments due as well.

Should met coal price weakness persist, Walter Energy could have to go to the debt market once more. Lately, bond investors demanded a hefty premium for their investments in Walter Energy's debt. The company has to pay 9.5% for $200 million first lien notes due 2019, and as much as 11% for its toggle notes due 2020.

In order to keep access to debt markets, Walter Energy has to stop cash outflow. This is not an easy task, as interest payments weigh heavily on the company's performance. In the first quarter, Walter Energy received $35.4 million of cash from operations, while it spent $12.3 million on capital expenditures. Going forward, Walter Energy's capital spending will increase.

The company projected $130 million of capital spending this year. Taking into account the first quarter figure, the run rate for capital spending will be closer to $40 million per quarter for the rest of the year. This will further complicate Walter Energy's task of keeping its existing cash position intact.

Could Walter Energy become a takeover target?
Walter Energy would have looked extremely cheap with its $321 million capitalization if the $2.9 billion debt load did not exist. Yet, the debt is there and anyone looking to buy Walter Energy will have to take its obligations as well. Given the amount of debt, only major miners like BHP Billiton (NYSE: BHP  ) or Rio Tinto (NYSE: RIO  ) can afford such a purchase.

Yet, this does not seem plausible in current environment as BHP Billiton's and Rio Tinto's cash flows are pressured by continuing softness in iron ore prices. Ironically, this does not prevent both companies from increasing iron ore output. In addition, both BHP Billiton and Rio Tinto contributed to current met coal oversupply. However, it is unlikely that major miners will be sponsoring even more met coal production growth.

Bottom line
Walter Energy is the cheapest bet on met coal price recovery. However, this recovery is not expected in 2014, and could mean further downside for Walter Energy's shares. On the other hand, if Walter Energy can show meaningful improvements on the cash flow side, its shares should rally.

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