What Are the Strategic Options for Walter Energy?

The recent Standard & Poor's downgrade of Walter Energy once again highlighted the fragility of the company's position. While risk-tolerant bargain hunters could buy Walter Energy's shares while they seem cheap at current levels, the company itself must find its way through the woods. Low met coal prices in combination with high indebtedness mixed into a dangerous cocktail for the troubled coal miner. While S&P believes that Walter Energy's debt level is unsustainable, what are the company's options to improve its financial condition?

Sell inventories
It would have been excessively optimistic to expect major cost improvements on Walter Energy's producing mines. The company has already gone through several rounds of spending cuts. The latest iteration brought this year's capital budget to sustaining levels of $130 million. Almost all met coal miners have followed Walter Energy's steps. For example, iron ore producer Cliffs Natural Resources, which also produces met coal, has recently announced a $100 million cut to capital spending. This cut made Cliffs Natural Resources' capital expenditures budget 65% lower than in 2013. Despite this effort, Cliffs Natural Resources has yet to convince investors it is on the right path.

In Walter Energy's position, the company must sell something to get more liquidity. The first target is obvious -- inventories. Walter Energy has a significant amount of coal in inventories after idling its Canadian operations. The company estimated that the sale of inventories raises its sales guidance by as much as 1.5 million tons. Last quarter, Walter Energy sold coal from its U.S. operations for $127.39 per ton. If the company is able to sell its inventories for $110-$120 per ton, it will receive an additional $165 million-$180 million in cash. However, this does not look like much compared to Walter Energy's $2.9 billion debt. To deal with this indebtedness, Walter Energy will have to take it a step further.

Sell Canadian operations
If we can think about one value-destructive thing that could be done to Walter Energy, it is the sale of its idled Canadian assets. Currently, they serve as a monument to greed and miscalculation, as they were acquired when met coal prices were at their peak levels. Surely, they are worth much less in the current price environment, and their sale will not bring value. What's more, it will be difficult to find a buyer for them. However, it is a viable option to keep the company afloat.

Even mining giants like BHP Billiton  are taking a cautious approach. As BHP Billiton finishes its previously started projects, there are no announcements of big new moves on the coal side. As BHP Billiton seems to be interested in the giant Northern Simandou iron ore project in Guinea, the company is less likely to fund additional met coal production.

There's also one important thing to consider. Walter Energy must not make the same mistake twice. The company already waited too long before idling its Canadian operations because it was hoping market conditions would improve. If the company decides to sell its Canadian assets, it must do it now. If it waits longer, assets from other distressed coal companies will flood the market, making prices for met coal assets exceptionally low.

Bottom line
Walter Energy has little room for maneuver, and selling assets is perhaps the most viable option. I do not believe further debt refinancing is possible following the recent downgrade by S&P. The good news is that the company still has time, but it has to use this time effectively.

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The article What Are the Strategic Options for Walter Energy? originally appeared on Fool.com.

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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