TEXT - S&P cuts Walter Energy rating to 'B+'

Tue Nov 6, 2012 4:14pm EST

Related Topics

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
FILED UNDER:
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.