What lies ahead for Walter Energy?

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Positive measures

Walter Energy (WLT) responded to the glut in the met coal market by idling high cost Canadian operations back in 2Q. While the company reported idling costs of $8.2 million in 3Q14, excluding take-or-pay charges to port operators, it expects the idling costs to come down to around $5 million each quarter.

So far, cost reduction measures have not resulted in much reduction in losses as the fall in prices has more than offset the cost reduction. However, the cost saving measures have at least helped the company maintain losses at the earlier level. The reduction in inventory is another positive over the last quarter.

part 8 exports to China

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Challenges continue

While Walter Energy has tried to optimize the controllable factors, the macro environment looks bleak. China is slowing and its steel demand is expected to peak by 2017-18. As a result, demand for met coal may further decrease. Moreover, China exempted its import tariff on Australian met coal in a recent trade agreement.

The exemption will make Australian met coal, which enjoys a logistical advantage over US coal, even more competitive. As a result, Australian met coal producers, including Peabody Energy (BTU), BHP Billiton (BHP), and Rio Tinto (RIO), may gain over American producers like Walter Energy.

Leverage

Walter Energy’s debt level is another huge concern. The company is taking desperate measures to conserve as much liquidity as it can to survive the downturn. The company has recently entered into debt-to-equity swap to reduce $52 million debt by issuing the creditors 3.9 million shares and $5.2 million in cash. However, large scale debt-to-equity swaps are unlikely.

While the company’s attempts to conserve liquidity and reduce debt are worth appreciating, the fact that the company’s future depends largely on recovery in met coal prices can’t be ignored.

Bottom line

Walter Energy seems to be in a better position than it was in a couple of quarters back. However, the fundamentals of the industry have worsened. Thus, the future of the company largely depends on how quickly the demand and prices pick up and whether the company has the benefit when prices do increase. For now, Walter Energy seems to be a risky bet.

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