Walter Energy: The Next Coal Casualty?

by Aaron Levitt | June 17, 2013 12:24 pm

Comparing investing in coal stocks like Walter Energy (WLT[1]) to riding a roller coaster would be understating coal’s hills and dips.

The hydraulic fracturing revolution sweeping America’s shale geology continues to unearth record amounts of natural gas and drive the fuel’s prices toward record lows — and that’s not sitting well with coal miners. As coal has battled with natural gas for electricity generation and steel-making prowess[2], shares of the various miners of thermal and metallurgical coal have been tossed around like rag dolls.

Already, we’ve seen dwindling share prices, mine closures and several bankruptcies of smaller mine operators. And despite the recent price increases for natural gas[3], the dark clouds in the coal sector continue to keep coming.

Now, the “pure play” metallurgical coal stock — Walter Energy — seems to be struggling hard, and bankruptcy rumors have begun to circle around the firm. For investors, the question remains whether shares of WLT are a value … or a value trap.

Canceled Refinancing

The general consensus from many analysts is that coal miners that specialized in metallurgical or steel-making coal would have the easiest time surviving any impending sector shake-out. Much of that thesis was built on the back of emerging-market growth and the demand for additional steel capacity to build out infrastructure in these nations.

Well, with slowing growth in key nations like China and new natural gas-fueled, direct-reduced iron (DRI) steel plants popping up across the U.S., the coking coal players have begun to suffer just as much as their electricity-focused brethren.

Which brings us to Walter Energy.

Since its founding back in the 1940s — as a homebuilder — Walter has expanded across several business lines and built itself up as one of the leading producers and exporters of metallurgical coal for the global steel industry. That focus on steel-making coal — which was a boon during the boom — has seemingly come back to bite the company.

As China, Brazil and other once-roaring emerging markets have seen their previously breakneck economic growth rates slow[4], demand for steel has dropped hard, and that has caused metallurgical coal prices to fall as well. Adding to those pricing pressures is the fact many miners haven’t cut output quickly enough to match that falling demand. In several mines, metallurgical coal prices no longer cover cash production costs, even for companies like Peabody (BTU[5]) that are considered to be low-cost producers.

This tough market has ultimately hurt Walter’s financial results — results that are even more bogged down by a high debt load.

Currently, Walter has too much debt at punishingly high interest rates. British hedge fund Audley Capital Advisors LLP — which recently lost a proxy battle against WLT — has contended that the miner is significantly overleveraged with $2.3 billion worth of debt[6], resulting in a net debt-to-book-value-of-equity ratio of 228%. This compares to peers’ ratios that range from 47% to 144%. Secondly, the company continues to add to that debt load at high interest rates; back in March, Walter issued a $450 million senior note offering at an 8.5% coupon rate.

Audley, along with other shareholders, urged the miner to cut its debt costs. Walter agreed to explore options to refinance part of its debt “to increase its financial flexibility.” Unfortunately, Walter decided to renege on this promise and recently withdrew a proposed $1.55 billion refinancing deal[7] that would have boosted liquidity and save the company big bucks.

Overall, news of Walter’s decision to not refinance sent shares tumbling by 17% last Friday to their lowest price since December 2008 on volume that was more than triple the daily average[8]. WLT shares were off another 7% by midday Monday, again on high volume.

Skip It

As I’ve previously highlighted, the coal sector continues to go through some pretty dramatic growing pains[9]. Overall, the shake-out is getting pretty nasty, and while Walter might not be a sure thing to follow Patriot Coal’s (PCXCQ[10]) lead into bankruptcy — and possibly to be joined by James River Coal (JRCC[11]) — I’m still wouldn’t want to place any bets on the firm.

As of this writing, 24% of WLT’s float was sold short[12], and that short interest was on its way up. Through the May 15-May 31 period, shares sold short increased 14% to about 17.05 million shares. This short interest makes sense given the firm’s aforementioned problems and the overall weakness in the coal market.

Walter might pull through — its assets are still worth something over the longer haul, and it still can cut its dividend if need be. But I’m not buying. Shares could still drift much lower as the shake-out continues. Overall, a high debt load, being in a struggling sector and rising short interest does not a comfortable investment make.

Investors looking to play any rebound in the coal sector are better suited chasing larger, relatively more stable names like Peabody or Arch Coal (ACI[13]).

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. WLT:
  2. steel-making prowess:
  3. natural gas:
  4. seen their previously breakneck economic growth rates slow:
  5. BTU:
  6. significantly overleveraged with $2.3 billion worth of debt:
  7. recently withdrew a proposed $1.55 billion refinancing deal:
  8. daily average:
  9. dramatic growing pains:
  10. PCXCQ:
  11. JRCC:
  12. 24% of WLT’s float was sold short:
  13. ACI:

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