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Steel is Keeping this Miner Down

Walter Energy (NASDAQOTH: WLTGQ  ) increased production in 2013. It increased the amount of metallurgical coal it sold by 5%. It reduced costs by 14%. But the company still lost $5.74 a share. The culprits were a nearly 10% drop in selling prices and one-time charges directly related to the weak met coal market. Walter is not alone.

A friend in need
Walter's met results are roughly similar to what's taken place at Teck Resources (NYSE: TCK  ) . Unlike Walter, the diversified Canadian miner was profitable in 2013, but not because of its coal operations. On the coal side, Teck sold a record amount of met coal, with notable demand growth in Asia.

Still, gross profit in the company's coal segment fell 45%. And it doesn't look like things are set to improve any time soon. For example, in the company's earnings release it noted that pricing for first quarter contracts are trending lower. The problem remains too much supply.

Not in 2014
The thing is that the oversupply situation is likely to linger through most of 2014. Walter CEO, Walter Scheller, noted in the company's fourth quarter conference call that while, "Global met coal demand has continued to modestly grow and is projected to continue... Global met coal supply was affected in 2013 by additional production from Australia." That new production isn't going to disappear in 2014.

Worse, Scheller echoed Teck's comments about pricing for the first quarter: "We expect sales volumes for the first quarter to exceed the fourth quarter of 2013. The pricing has weakened with the first quarter benchmark price declining versus Q4."

Part of the problem with Australian met coal is that large diversified miner like BHP Billiton (NYSE: BHP  ) and Rio Tinto (NYSE: RIO  ) are big players. Unlike Walter, this pair was profitable in 2013 and have plenty of financial strength to weather the weak met market. Walter, on the other hand, has been fending off questions about whether or not it will pass debt covenants when they come into play later this year.

Getting to the other side
Right now, the big game in the met market is survival. Gregory Boyce, CEO of globally diversified coal miner Peabody Energy (NYSE: BTU  ) , noted in his company's fourth quarter conference call that, " can only have [the] strategy of losing money and waiting and sitting for so long." For example, James River Coal (NASDAQOTH: JRCCQ  ) is exploring "strategic alternatives," up to, and including, the sale of the company. Clearly James River is at a point where it can't wait any more.

When asked about the logic behind turning some purchasers away because of low prices, Walter senior vice president Michael Madden noted that competitors are taking the low prices. But, he thinks, "...a lot of it is last-ditch stuff, particularly if it's a... smaller operator. But [at] some of the numbers that are being thrown out there, it's not going to keep them above water very long."

Good news bad news
Pricing that's so slow it isn't worth selling the coal is clearly bad news. However, if Peabody and Walter are right, 2014 could be the year that companies roll over and supply gets cut back. James River is a clear sign that this trend could be starting. So that's good news.

But will the turn come soon enough? The answer to that question depends on the company you are talking about. Clearly a turn didn't come in time to pull James River out of its funk. Walter is in better shape, but continued price weakness could be a problem if lasts through the entire year. Only aggressive investors should be looking at it.

Teck, Rio, Peabody, and BHP will almost certainly come out the other in much stronger positions then when they entered the met downturn. Peabody is the only coal-focused player of the quartet if you are looking for a direct coal investment. The other three offer exposure to more commodities and have proven to be more stable businesses.

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Reuben Brewer

Reuben Gregg Brewer believes dividends are a window into a company's soul. He tries to invest in good souls.

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