-- 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.
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.
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
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.
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
For our full recovery analysis, see our recovery report on Walter Energy,
published Feb. 28, 2012, on RatingsDirect.
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
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Ratings Lowered; Outlook Negative
Walter Energy Inc.
Corporate credit rating B+/Negative BB-/Negative
Senior secured B+ BB-
Recovery rating 3 3