Walter Energy Inc: Avoid on Debt Concerns

After questionable debt financing and weakening met coal markets, investors should avoid Walter Energy in favor of sector stocks that raised cash last year.

Mar 21, 2014 at 9:46AM

With Bank of America issuing a negative report on metallurgical coal, Walter Energy (NASDAQOTH:WLTGQ) slumped 20% on the news. The analyst was also bearish on other met coal producers including Alpha Natural Resources (NYSE:ANR) and Arch Coal (NYSE:ACI). Typically a beaten down stock would grab some interest in the market, but in the case of Walter Energy, recent debt financings and weak prices for met coal make it questionable whether the stock will rebound.

Walter Energy is the largest pure play, met coal miner in North America with operations primarily in Alabama and Canada. The stock was a poster child for the booming commodity sector back in 2011 when it soared to over $140 on relentless demand from China. Now, the stock has a prominent firm placing a $2 target on the stock.

While the thermal coal market is expected to rebound due to the jump in natural gas prices, met coal is dependent on steel demand and, more importantly, high growth in China and emerging markets. Recent supply increases in Australia along with cooling demand growth has crushed pricing with the analyst from Bank of America expecting even more weakness.

Debt financing
The problem with investing in a stock like Walter Energy is that large losses make it difficult to ensure the company will survive. This week, the company raised $550 million via a $200 million offering of senior secured notes and a $350 million offering of senior secured second lien PIK toggle notes. For those investors unfamiliar with a PIK, or payment in kind, toggle note, it allows the borrower in each interest period to pay interest in cash or to PIK the interest payment. In essence, the note allows the company to delay cash outlays until in the future when the business hopefully turns around. This financing option is typically an expensive, high-risk instrument.

Continued losses
On average, analysts expect losses to increase to $3.80 per share in 2014 and drop to a loss of $1.72 in 2015. More importantly, the trend is significantly to the downside with expectations for 2014 losses plunging over the last 90 days from $1.82 to $3.80.

While losses don't make a stock un-investable, the debt position and earnings trend make the decision very difficult. As an example, Nuverra Environmental Solutions (NYSE:NES) faces a similar scenario of continued losses in a somewhat related industry. The company was in the process of developing a full suite of environmental solutions for the oilfield services sector, but it ran into a weak pricing situation that crashed EBITDA results in 2013. Though the stock has sold off and analysts continue to expect losses, Nuverra is more investable due to an improving environment for its services and a recent upsizing of the revolving credit facility. The company was able to increase a revolving credit facility by $45 million to $245 million while keeping similar terms. The stock is now on an upswing instead of collapsing like Walter Energy after the questionable debt financing.

Other players
With Walter being a high-risk situation now, investors can benefit from investing in sector stocks pushed down by the fears. In that case, both Arch Coal and Alpha Natural Resources appear to provide better options. Arch Coal raised around $435 million by selling the non-core assets of Canyon Fuel Company and Alpha Natural sold a joint venture with Rice Energy (NYSE:RICE) for $200 million of stock and $100 million in cash, for total consideration of $300 million. Rice Energy went public in Jan. to huge success providing upside for the remaining $200 million investment.

The ability to raise cash by selling assets places these two stocks in a better position to thrive, not to mention the thermal coal assets benefit from the surge in natural gas prices.

Bottom line
Investors need to stay away from Walter Energy with the losses mounting up and questionable debt financing. If an investor wants to invest in the beaten up coal sector, Arch Coal and Alpha Natural Resources offer better options after raising cash prior to the recent weakness.

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Mark Holder and Stone Fox Capital clients own shares of Alpha Natural Resources and Nuverra Environmental Solutions. The Motley Fool owns shares of Nuverra Environmental Solutions. 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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