Location Matters, Just Ask Walter Industries and BHP Billiton

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The upheaval in the metallurgical coal market shows no signs of abetting. The big Australian producer, BHP Billiton  (NYSE: BHP  ) , is growing production and investing in new infrastructure to compensate for lower prices. It is flooding the market, pushing prices lower and putting nails in the coffins of higher-cost mines. Walter Industries (NASDAQOTH: WLTGQ  )  is the latest casualty.

Disadvantaged coal producers will have a tough time selling high-cost assets without taking big cuts. Now is the time for investors to bet on the well-positioned players and let disadvantaged players struggle.

North America versus Australia 
BHP Billiton's Australian Queensland operation accounted for 79% of its fiscal 2013 metallurgical coal production. In fiscal 2013, the operation produced $627 million in underlying EBITDA with an EBITDA margin of 14%.

Walter Industries is on the other side of the Pacific with very different numbers. Its Canadian and U.K. 2013 average hard coking coal selling price per metric ton was $144.45, yet its cash cost of sales was $153.38 per metric ton. With these numbers, it is no surprise that it recently decided to idle its Canadian mines and lay off 700 workers.

Walter Industries' U.S. operations are better. Its 2013 average hard coking coal selling price per metric ton was $144.89, and its cash cost of sales was $102.36 per metric ton. The issue is that Walter Industries has a total debt-to-equity ratio of 3.7 and is dependent on the U.S. for profits at the same time that competition is heating up. From March 2013 to March 2014 alone, BHP Billiton boosted its Queensland coking coal production by 32%.

Other miners tell the same story 
Alpha Natural Resources (NASDAQOTH: ANRZQ  ) is also suffering. Alpha Natural Resources' mines are in the U.S. and metallurgical coal is a big portion of its revenue. In 2013, metallurgical coal comprised 47% of its 2013 revenue, making it a significant portion of its bottom line. 

Alpha Natural Resources' metallurgical production is found in its Eastern operations, and it is not too surprising that its eastern operations posted an EBITDA loss of $44 million in 2013.

Back in the early 2000s, not every U.S. coal miner was content with the status quo. Peabody Energy  (NYSE: BTU  ) , for example, spun off Patriot Coal and has focused on developing metallurgical assets in Australia instead. In 2013 it posted positive gross margins in Australia and its U.S. segments. Its 2013 Australian gross margin per ton of $9.08 is less than the $28.42 it posted in 2012, but it is profitable none the less.

Respect the power players
BHP Billion is a diversified miner with the deep pocketbooks required to endure downturns. In 2014, the global coal market is expected to be oversupplied by 2.3% of global imports, a big enough number that the prices could fall even further. Peabody is a pure coal play, but Peabody's mix of U.S. and Australian assets is big strength.

Walter Industry is on the other side of the fence. Its high debt load could spell real trouble if prices continue to fall. Alpha Natural Resources is also in a tough spot even though its debt load is only 0.84. U.S. metallurgical coal is such a big portion of Alpha Natural Resources' business that falling prices will have a big impact on both profits and its stock price.

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Joshua Bondy

Joshua Bondy works in the energy and materials sector. He works hard to bring to light the underlying forces that drive prices and move the market.

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