Dilution Is a Real Threat to Walter Energy's Shareholders

Moody's has recently joined Standard & Poor's in downgrading Walter Energy (NYSE: WLT  ) , the troubled met coal miner that struggles from huge debt and low met coal pricing. Moody's downgraded Walter Energy's corporate family rating to Caa2 from Caa1, pushing it further into junk territory. The rationale presented by Moody's is similar to the one outlined by Standard & Poor's: low met coal prices lead to cash burn and difficulties with servicing existing debt. Walter Energy has been busy refinancing its existing debt, cutting costs and optimizing production levels, but it could need even more drastic measures to stay afloat.

Debt markets still open for Walter Energy
Walter Energy stated that the benchmark met coal price fell from $143 per ton in the first quarter to $120 per ton in the second quarter, making a 16% decline from already low levels. Despite this, Walter Energy was able to issue $320 million of 9.5% senior notes due 2019, intending to use $298.1 million to repay indebtedness outstanding under its revolving credit facility.

The fact that Walter Energy was able to get an interest rate under 10% is a big positive for the company. Walter Energy got the same rate in September 2013, when it was issuing $450 million of senior notes due 2019. The access to debt markets is crucial for Walter Energy, so the sole fact of successful debt issue is a step forward.

Back in May, Walter Energy's peer Alpha Natural Resources (NYSE: ANR  ) was able to issue $500 million of 7.50% second lien notes due 2020. Another coal miner, Arch Coal (NYSE: ACI  ) , sold $350 million of 8% second lien notes due 2019 in December of 2013. Both Alpha Natural Resources' and Arch Coal's second lien notes received rates lower than Walter Energy' first lien notes, highlighting the fact that investors are very worried over Walter Energy financial condition. Thus, although the interest rate environment remains tough for most coal miners, it's especially tough for Walter Energy.

Importantly, the new debt issue increased Walter Energy's interest expenses once again. Interest expense weighs heavily on the company's performance. In the first quarter, Walter Energy spent $79.4 million on interest payments. It looks unlikely that Walter Energy could proceed with issuing more high-yield debt in the future, as it will put a heavy burden on its cash flows. However, there is an option to reduce indebtedness and interest payments.

Swapping debt for equity is possible
Walter Energy could choose to offer bond investors an option to swap debt for Walter Energy's shares. This move will reduce Walter Energy's debt and, perhaps most importantly in current situation, will reduce interest expense. Surely, this will dilute existing shareholders and pressure Walter Energy's shares. However, the company's future is at stake, and swapping debt for equity is a viable option.

When Standard & Poor's explained why it decided to downgrade Walter Energy at the end of June, it mentioned reduced production expectations as one of the reasons for the downgrade. Walter Energy decided to idle its Canadian operations back in April, and lowered its met coal production guidance to 9 million–10 million tons. Walter Energy's recent report showed that some of the risks materialized.

Difficult geological conditions at company's Mine No. 7 lowered production by almost 100,000 tons in the second quarter. Despite these challenges, Walter Energy still expects to meet its full-year production guidance. Walter Energy planned to sell more than it will produce this year due to the sell-off of Canadian inventories, so the sales numbers are more important.

Walter Energy reported preliminary met coal sales of 2.7 million tons in the second quarter. The company sold 2.6 million tons of met coal in the first quarter, so it is on track to reach the low end of its sales guidance of 10.5 million–11.5 million tons. However, it will be good for the company to accelerate the pace of inventories' sales in the second half of the year and reach the high end of sales guidance.

Bottom line
High interest expense burden could force Walter Energy to offer investors an option to swap debt for equity. While this will likely have a deteriorating effect on the company's share price in the short term, it will remove some of the interest expense burden. Hopefully, Walter Energy will give more clues on how it is going to deal with existing indebtedness when it reports its second quarter earnings.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.


Read/Post Comments (1) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 18, 2014, at 12:19 PM, Paulson545 wrote:

    Coal is dead NGas is the clean energy source of the future. There are sanctions against Russia, Russia might retaliate by cutting off the flow of NGas to the west. The west will than look to America to make up the shortfall. Canaccord Genuity just put a $51.00 price target on Rice Energy, if everything plays out this PT could be too low...jmho...Coal will break your heart.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3031498, ~/Articles/ArticleHandler.aspx, 8/21/2014 12:29:03 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement