Is S&P Right on Walter Energy?

The troubled met coal miner Walter Energy (NYSE: WLT  ) has just received another blow. Standard & Poor's has cut its corporate credit rating to CCC+ from B-. S&P argues that Walter Energy's debt level is unsustainable because of the low met coal price and reduced production expectations for the company. What's more, S&P sees no improvement on the met coal front over the next 12 months, and expects that low met coal prices will eat into Walter Energy's liquidity position.

Reduced production is not that bad for Walter Energy
Interestingly, S&P sees reduced production expectations as negative for Walter Energy. Back in April, the company decided to idle its Canadian operations. This move resulted in a significant change in production expectations. Prior to this decision, Walter Energy expected to produce 11 million–12 million tons of met coal. In its first quarter earnings report, Walter Energy announced a revised production guidance of 9 million–10 million tons of met coal.

However, the company was planning to sell more than it produced because of significant inventories in Canada, and the sales guidance came at 10.5 million–11.5 million tons of met coal. Walter Energy's Canadian and U.K. segment contributed to a $53 million loss in the first quarter. It's unlikely that investors would seriously miss unprofitable Canadian production, so S&P's point about reduced production is at least debatable.

Who's next?
What's not debatable is the seriousness of the liquidity problem in the long run. Walter Energy has to service a $2.9 billion debt, and it's a tough challenge in the current pricing environment. The company has freed itself from short-term liquidity issues by issuing $550 million of debt in March, but the interest rates were very high. S&P's decision to cut the company's rating could make the rates on future debt even higher.

Walter Energy's access to debt markets is crucial for the survival of the company. If the company makes it through the next several years, it will have to repay $1 billion in 2018 under its 2011 credit agreement. For this one, the ability to refinance at reasonable rates is paramount.

Will other coal miners follow? Currently, S&P has a B rating for both Alpha Natural Resources (NYSE: ANR  ) and Arch Coal (NYSE: ACI  ) . According to S&P, the outlook for Alpha Natural Resources and Arch Coal is stable, while the outlook for Walter Energy is negative.

Arch Coal's exposure to met coal is limited, while thermal coal markets are showing signs of stabilization. What's more, Arch coal has a substantial liquidity position. Thus, the rating cut for Arch Coal is not on the table, at least for now.

Alpha Natural Resources' situation is different, given the fact that company's exposure to met coal is almost equal to its exposure to thermal coal. Just like Walter Energy, Alpha Natural Resources carries a pile of debt due to ill-timed acquisitions back when coal prices were rallying. While Alpha Natural Resources' liquidity position looks decent, the company's exposure to met coal markets could put pressure on its credit rating in the future.

Bottom line
Walter Energy is a speculative bet on a met coal revival. In this light, S&P's downgrade is not big news and reflects the true state of things. Walter Energy's second-quarter report will be of utmost importance, as it will show whether the company was able to stop the cash outflow that was caused by its Canadian operations. Walter Energy has bought itself some time with its recent debt issue, and now it has to use this time wisely.

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  • Report this Comment On July 04, 2014, at 8:09 AM, jpokergman wrote:

    At a macro level, the economy is heating up faster than anyone expected. Steel companies have recently caught a bid. Most importantly the largest purchaser of steel products (the Pentagon) looks as though it is about to ramp up fresh demand for continued Iraq operations, this time, with no end in sight. Civil Wars tend to be long lasting, as emotions run deep. Washington has an idiot in charge, so this ought to cost dearly. By the time the nitwits at the S&P figure this out WLT, could be in the 30's.

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