Beleaguered shareholders of this coal miner probably feel like
Lee Dorsey in the classic 1966 song "Working in the Coal
"Lord! I'm so tired! How long can this go on?"
That's a good question. It's been a wild ride for
Walter Energy (
over the past seven years.
The share price is lower than it was during the apex of the
financial crisis. But while there was a massive sell-off of all
types of assets in 2008 and 2009, current conditions seem much
So what gives?
The End Of The Supercycle
With explosive economic growth inemerging markets such as the
BRIC nations (Brazil, Russia, India and China) has come a rapid
escalation incommodity prices based on what has seemed like an
insatiable need for raw materials. Commodity producers and
investors have enjoyed very good returns. How good? This 10-year
chart of the S&PGSCI Commodity Index says it all.
But these days? Not so much.
As the U.S. dollar strengthens, commodity prices (contracts
are priced in dollars) soften internationally by sheermarket
However, the psychological reasons for the downturn stem
mainly from the fear of an economic slowdown in the emerging
markets (primarily China) and the continued weakness in global
demand due to the slow recovery in the U.S. and the persistent
malaise in the eurozone economies.
But what does all of this have to do with a coal producer in
Birmingham, Ala.? Plenty.
The Other 'Clean Coal'?
An important input commodity, coal -- especially U.S.-produced
coal -- has seen its price rise and fall violently in recent
years. The first part of the 21st century saw thermal coal prices
rise nearly fourfold from around $40 per short ton to $140 in
2008, which coincided with the global financial crisis. Since
then, prices have settled back to around $55 per short ton.
In the industrialized world, coal is primarily used for two
things: as fuel to help generate electricity and to make coke for
A large, fast-growingeconomy such as China uses alot of coal
for both purposes. However, China is also the world's largest
coal producer, with the United States a distant second.
Should a slowdown in China affect what happens to coal
domestically? Not really, but federal government regulation
Since both Bush administrations and the first Obama
administration, the U.S. has had virtually no concrete energy
policy. It's no secret that the current administration is no fan
of coal from an environmental standpoint.
Compounding those worries, large power producers have switched
en masse to natural gas as a cheap, clean fuel source. Obviously,
that doesn't help prop up prices. So it makes sense that
thestocks of domestic coal producers have been beaten up over the
past few years.
However, Walter produces primarily high-quality metallurgical
coal that is used in steelmaking. Is the market throwing the baby
out with the bathwater?
The company's numbers look terrible: negativeearnings for 2013
with ananalyst consensus of a loss of $1.43 a share; weak Chinese
demand (although China is a large coal producer, they produce
very little high-quality metallurgical coal); and coking coal
prices down 18% to a recent price of around $140.
To give the market even less confidence, Walter recently
postponed proposed refinancing of $1.6 billion interm loans ,
citing market conditions. Most investors wouldn't touch this idea
with a 10-foot pole. But look beneath the surface.
||This overland conveyer transports coal from Walter
Energy's mining operations in Alabama.
Walter Energy is in a fairly simple business: It owns and
produces atangible asset . Conservative estimatesput Walter
Energy's tangiblebook value at around $16 a share. Much of that
is tied to the company's coal reserves (coal in the ground). That
wasn't a big deal whenshares were trading north of $100, but with
shares staggering around $11.50, it's a different story -- that's
45%upside . The value is literally buried in the ground. But the
story gets better.
As far as the metallurgical segment -- Walter's bread and
butter -- goes, demand has stabilized, albeit at lower levels.
According to the U.S. Energy Information Administration, coking
coal domestic demand for 2013 should slip about 1.4% from
lastyear , to 20.5 million tons. Not a disaster.
Imports are a different story. Last year, import demand stood
at 125.7 million tons. This year's forecast is pretty grim at
107.1 million tons, a 14.8% drop. However, the 2014 forecast for
coking coal imports appears stable at 108.4 million tons. A
modest increase of just 1.2% leaves some room for an upside
As far as Walter Energy is concerned, the picture, believe it
or not, is getting brighter. Forget about 2013:Sales should come
in at around $2.1 billion versus $2.5 billion last year, which
would be an ugly 16% drop. However, forecasts for 2014call for
sales of $2.3 billion, which would be an impressive 9.5%
improvement over 2013.
Cash flow is also improving. After a negative 98 cents per
share last year,free cash flow has turned positive to about 48
cents per share. That's expected to climb more than 170% next
year to a projected $1.31 per share. The companywill accomplish
this through tightercapital controls and eliminating thedividend
While I normally don't like to see dividend cuts, this is
necessary for the survival of the company and actually adds more
value to a deeplyundervalued stock .
Last, the hope of all stock investors: Walter Energy is
rumored to be atakeover candidate. Whenever certain sectors
become depressed,consolidation often follows. Possible suitors
Alpha Natural Resources (
Brazilian miner Companhia Siderurgica Nacional (
andWarren Buffett 's
Berkshire Hathaway (NYSE: BRK)
. Based on the unlocked assets at Walter, that idea is right up
the Oracle of Omaha's alley.
Risks to consider:
By its nature,contrarian deep-valueinvesting is extremely
risky. As an investor, you're buying into an idea or event that
may very well fail to materialize. As a business, Walter Energy
is in a precarious position. One way to protect yourself would be
to use astop-loss order 15% to 20% below your purchase price.
Another way would be to use options tohedge your long position.
(My colleague Amber Hestla-Barnhart covered this in great depth.)
Finally, the coal industry is depressed and very sensitive
economically. Continued global economic weakness would likely
suppress this idea.
Action to take -->
Walter Energy is clearly undervalued, based on the company's
improving internals and improving macro conditions, a
12-monthprice target of $16 would bring the company back to its
book value. Shares currently trade around $11.50. This would
represent a 40% return. The annual 50-cent-a-share dividend gives
the stock ayield of about 4.4%. Don't count on it being that high
forever, but this will help the company in the long run.
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