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The continued fragile met coal market and prices have adversely affected the U.S coal industry. The coal ETF (NYSEARCA:KOL) is down 26% year to date as compared to a 14% increase for the S&P 500. Met coal prices have fallen to such low levels that most of the coal producers are unable to even cover their full variable costs, which certainly is a grave threat to the industry. One of the most critical things for the industry is the need for a recovery in coal prices; and for this to occur production needs to be cut down and demand should bounce back. Met coal prices have plunged more than 20% since February.

Global steel consumption, which will drive demand for met coal, is expected to grow by 3% in 2013, as compared to 1.2% increase in 2012. However, there are some risks faced by the coal industry including a slow down in Chinese demand growth for met coal and the eurozone crisis. Other than demand and supply improvement, the coal companies are also working to improve their cost structure that should help them survive through tough market conditions.

Walter Energy (NYSE:WLT) is primarily involved in the met coal business, and given the tough market conditions the stock price is down 62% year to date. Besides weak coal market conditions WLT has a highly leveraged balance sheet, with long debt to equity of 275%, which poses significant risk for the company and has contributed to recent stock price plunge. Earlier this month, Moody's lowered its credit rating for WLT, from B1 to B2, due to downturn in met coal markets. Currently WLT is assigned 'B2' credit rating by Moody's and 'B' by S&P.

Recently, the company withdrew its plan to refinance $1.55 billion worth of debt, the news was negatively absorbed by the market as the stock price tanked 17% on the day. On the 20th June, S&P placed WLT on credit watch with negative implications as WLT disposed its refinancing plan ahead of a significant maturity in 2015. In an effort to avoid a covenants breech WLT is expected to get amendments in its credit agreement, following the company plan to not opt for refinancing. The amendments in the credit agreement will come at a cost of additional demands from the lenders. However, these additional demands are uncertain and likely to remain an overhang for the stock price.

I believe, the company does not have any immediate liquidity needs, given its healthy cash balance of $236 million at the end of the recent first quarter. Also, WLT does not have any significant debt maturity repayment until 2015. In 2015 and 2016 WLT has scheduled debt repayment of $523 and $163 million respectively and additional funding will be required by 2015 to cover these repayments.

Outlook
WLT expects sales price per ton for met coal to be improving vaguely in the ongoing second quarter, as compared to the recent first quarter. In efforts to improve the cost structure WLT anticipates to reduce its per ton met coal cost of production and cost of sales by more than 5% in the ongoing second quarter.

For the full year, 2013, WLT coal production is forecasted to be 11 million tons, down 6% on a year on year basis. On the other hand, per ton costs are expected to be 15% lower on a year on year basis.

Conclusion
I believe, the met coal market is most likely to improve in the long term, as steel production and consumption will improve. However, near term met coal markets are likely to be uncertain, combined with a highly leveraged balance sheet and an uncertain outcome of amendments in debt convents for WLT add to risks faced by the company. The magnitude and timing of coal production cut will decide the time span and level of recovery in the met coal market. Therefore, in the short term WLT stock price is likely to remain volatile; whereas in the long run as the met coal market will improve it is most likely to bode well for the company.

Source: Walter Energy: Overhangs To Prevail In The Short Term