TEXT - S&P cuts Walter Energy rating to 'B+'
Overview -- In our view, metallurgical coal prices, which have declined dramatically in 2012, are likely to remain low in 2013 because of slower global steel production. -- Low coal prices as well as initially high costs at recently acquired Canadian mines are likely to drive U.S.-based miner Walter Energy Inc.'s leverage to about 5x EBITDA. -- We lowered our ratings on Walter Energy Inc., including its corporate credit rating to 'B+' from 'BB-'. -- The negative outlook reflects the potential for another downgrade if global economic conditions weaken further and cause the company to maintain leverage above 5x and strain its liquidity. Rating Action On Nov. 6, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Walter Energy Inc. to 'B+' from 'BB-'. At the same time, we lowered our rating on the company's senior secured bank debt to 'B+' from 'BB-'. Our recovery rating on the secured bank debt remains unchanged at '3' and indicates our expectation for meaningful (50%-70%) recovery in the event of default. The outlook remains negative. Rationale The downgrade reflects our expectation that Walter Energy's leverage will climb to about 5x next year due to sharply lower metallurgical (met) coal prices, as well as higher-than-expected operating costs at its recently acquired Canadian mines. This is well above our previous expectations and indicative of an "aggressive" financial risk profile, in our view. These conditions caused the company to write down all $1.1 billion of goodwill related to its 2011 acquisition of Western Coal Corp. and negotiate more flexibility under restrictive leverage covenants governing its revolving credit facility. We are maintaining our negative outlook on the company given difficult market conditions and the company's significant capital expenditure needs. Our ratings on Birmingham, Ala.-based Walter Energy reflect our view of the company's "weak" business risk and its aggressive financial risk. Key risks include a cyclical slowdown in steel production that is suppressing demand for met coal, a high reliance on a single Southern Appalachian mining complex for most of its operating income, and elevated debt levels related to the company's $3.3 billion acquisition of Western Coal Corp. Still, we maintain our view that Walter Energy's coal reserves are of a very high quality and that its mining costs are comparably low. Therefore, we expect its credit metrics to improve when this cycle turns and met coal prices rebound, though the timing of a recovery is uncertain. The third quarter (2012) benchmark met coal price (against which Walter Energy and other producer's prices are pegged) dropped to $225 per metric ton, down 29% from a year earlier. Fourth-quarter benchmark prices fell further to $170 per metric ton, with spot prices even lower. Given this price environment, we expect Walter Energy's EBITDA to drop below $550 million in 2012--even if the company hits the upper end of its production guidance (13 million tons). This is down from our previous EBITDA estimate of $700 million-$800 million for 2012 and would imply leverage of about 5x based on $2.7 billion of debt (including pension and other adjustments). Our estimates for 2013 assume that benchmark prices remain below $200 and that Walter Energy's production climbs above 15 million tons. Based on these assumptions, we expect about $600 million of EBITDA with leverage near the middle of the 4x-5x range. We also expect funds from operation (FFO)-to-debt to be near the lower end of the 12%-20% range through 2013. Both ranges are consistent with an aggressive risk financial profile. Walter Energy mines met coal, which is used primarily in steelmaking. Its underground mines in Alabama contain high-quality coal and typically achieve pricing close to the industry benchmark. Its longwall mining operations (a highly productive mining technique) contribute to low costs relative to peers that use less efficient techniques. These Alabama mines accounted for nearly all of the company's operating income in the first half of 2012, partly because of lower-than-expected production and higher costs at its recently acquired Canadian sites. Liquidity We view Walter Energy's liquidity to be adequate based on the following assumptions and observations: -- The company has successfully negotiated relief under restrictive leverage covenants, which support our view that Walter Energy has solid relationships with its lenders; -- We expect sources of liquidity to exceed uses by more than 1.2x over the next 12 months; and -- We expect liquidity sources to exceed uses even if EBITDA were to decline 15% from our current estimates. We expect the company to generate about $350 million of cash from operations in 2012 and between $400 million and $450 million in 2013. Liquidity uses include between $200 million and $300 million of maintenance and expansion capital expenditures and about $30 million of dividends. Walter Energy does not have any meaningful maturities in the balance of 2012 or in 2013. Walter Energy had $130 million of cash on Sept. 30, 2012, and $167 million available on a $375 million revolving credit facility on June 30, 2012--net of borrowings and outstanding letters of credit. The credit facility is governed by restrictive financial covenants, which the company recently amended for a second time in 2012. The covenants now permit leverage up to 6.25x through the first three quarters of 2013 and ratchets down thereafter to 4.5x by September 2014. We expect the company to remain in compliance with these new, more flexible covenants. Recovery analysis For our full recovery analysis, see our recovery report on Walter Energy, published Feb. 28, 2012, on RatingsDirect. Outlook The negative outlook reflects our view that Walter Energy's leverage is likely to climb to about 5x EBITDA in 2012 and is likely to remain at or above 5x into 2013. We would lower our rating if leverage continues to rise and is sustained well above 5x. This could occur if met coal prices continue to deteriorate because steel manufacturing further slows weaker-than-expected global economic conditions. An upgrade is unlikely in the current environment, but we would revise our outlook to stable after the company eases its covenant pressures and maintains leverage in the 4x-5x range. Walter Energy could maintain this level of leverage if coal prices stabilize or improve and perpetuates current productions levels in Alabama while improving production levels and lowering costs in Canada. Temporary telephone contact numbers: Marie Shmaruk (973-986-7965); James Fielding (917-734-3477). Related Criteria And Research -- Industry Report Card: U.S. Natural Resources Split As Housing Boosts Building Products Companies While A Tough Market Puts Coal Miners Deeper In The Hole, Oct. 8, 2012 -- Issuer Ranking: U.S. Metals And Mining Companies, Strongest To Weakest, Oct. 2, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Lowered; Outlook Negative To From Walter Energy Inc. Corporate credit rating B+/Negative BB-/Negative Senior secured B+ BB- Recovery rating 3 3
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