Walter Energy (WLT +0.00%) recently announced that it had amended a credit facility in July. That move helped keep the company on the right side of its debt covenants. However, that rework was accompanied by a dividend cut. Now that the bad news is out, however, the question is whether or not Walter has enough staying power to outlast the metallurgical coal downturn.
Met coal
Walter is largely focused on met coal, which is used in the steel making process. Its current woes stem from, in hindsight, an ill-timed 2011 acquisition that cost around $3.3 billion. About a third of that was written off in 2012. Because of those two corporate actions, long-term debt currently sits at about 75% of the capital structure, up from around 20% prior to the acquisition and 50% after the purchase closed but before the write-off.
Clearly that one purchase has had a profound effect on Walter in a not so good way. While a few years ago the company could have boasted of its financial strength, today it is trying to show that it can survive the current downdraft in the met coal market.
For example, Walter has been focusing attention on its cash position and debt maturity profile. That's not the normal course of action for financially strong companies. On that front, however, the company seems to be doing a decent job. In fact, it won't face its first significant debt maturity until 2015. And it has some financial breathing room between its cash on hand and credit facilities. The company also recently announced plans to issue new debt to retire older debt, which should further solidify its near-term financial position.
And Walter isn't the only coal company with a notable debt load. For example, Natural Resource Partners (NRP 0.72%) is issuing debt to pay for a recent acquisition. Although the opportunistic purchase has helped to diversify this coal leasing company, it has also taken debt up to around 80% of its capital structure. That said, leasing coal mines to others is vastly different than running coal mines yourself, so Natural Resource Partners is probably better positioned to handle a high debt load. Still, that much debt will limit the company's growth prospects.
Met vs thermal
And, despite the tough market today, met coal doesn't face the same challenges as thermal coal. Proposed Environmental Protection Agency (EPA) rules regarding carbon dioxide emissions, for example, have been likened to an outright ban on new coal-fired electric plants. And rules for existing electric plants are expected to be proposed next year.
For a company like Cloud Peak Energy (CLD +0.00%), which is almost exclusively focused on thermal coal, that's not good news. Even though the company is working on growing its export business, which represents around 5% of its coal volume, getting coal abroad is still a small slice of the overall pie. Met coal isn't facing that regulatory headwind, at least not yet.
And demand for met from key growth markets remains strong, despite price weakness driven by oversupply. For example, Peabody Energy (BTU +0.00%) is expecting met coal demand to grow about 3% globally this year. That will be driven by notable demand growth in Asia, partially offset by weakness in European demand. That's good news for Peabody, which mines met coal in Australia, just a hop skip and a jump away from China.
That said, the company is broadly diversified, with about half of its business in U.S. thermal coal. So the EPA rules are as troubling here as they are at Cloud Peak—though at around 40% of electric production there's little chance of coal going away overnight. Australian thermal and met coal make up the rest of Peabody's business. Walter, then is a more leveraged play on a met coal rebound, while Peabody is likely a less risky investment overall despite the EPA rule overhang.
European weakness
Peabody's growth forecast, however, shows that there's another fly in Walter's ointment—Walter sells about 40% of its met coal into struggling Europe and only 30% or so into higher growth Asia. Although customer diversification is generally a good thing, in the near term it's likely to be a top- and bottom-line hindrance. So even making it through the weak spot won't necessarily translate into robust growth.
Don't count 'em out
Walter's high debt load means it has a rough climb ahead even if met coal pricing and demand pick up. Conservative investors should probably stick to a globally diversified coal miner like Peabody. That said, for those expecting a met rebound, Walter has much more upside potential. But that's only if you are willing to keep a close eye on the balance sheet of a highly leveraged company that's lost money for four consecutive quarters.
