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Walter Energy (NASDAQOTH: WLTGQ ) was once a high-flying stock. It closed as high as $141/share on April 8, 2011. Fast forward three years, the stock is under $6, down about 95%! Since mid-2011, the benchmark premium hard, low-vol coking coal price has fallen by a staggering 64% from $330 to $120 per metric tonne. This is a complete disaster for Walter, but also for every other coking coal producer on the planet. Other coking coal heavy names that have been slaughtered since 2011 include Arch Coal (NYSE: ACI ) , down 90%, Alpha Natural Resources (NASDAQOTH: ANRZQ ) , down 95%, and Peabody Energy (NYSE: BTU ) , down 82%.
Walter, Arch, Alpha, and Peabody all made debt-financed, top-of-the market acquisitions in 2011. The only significant U.S. producer that did not fall prey to this ill-informed strategy was Cloud Peak (NYSE: CLD ) . Cloud was smart to stay away from the use of debt and concentrate on cutting costs in its main area of operation, thermal coal in the Powder River Basin of Wyoming. As a result, Cloud Peak's stock has vastly outperformed peers, but is still down from 2011.
Arch chased the coking coal frenzy by acquiring east coast producer International Coal. International Coal had what appeared to be a promising mid-vol coking coal project that was three years from production. When low-vol coking coal prices were at $330 per tonne, this deal might have looked good at the time. Arch is now burdened with $5 billion of debt, despite a market cap of just $770 million. Alpha fared no better with its acquisition of Massey Energy, also in 2011. Even though Alpha used a considerable amount of equity in the transaction, Alpha today remains saddled with $3.4 billion of debt on a market cap of $900 million.
Peabody Energy acquired a company in Australia that expanded its non-U.S. and non-thermal coal portfolio. However, that acquisition was not of pure low or mid-vol coking coal, but a coal called "PCI" coal. This specialized coal has not lived up to expectations. Peabody's debt burden is less on a relative basis than Walter's, Arch's, or Alpha's, but it's still a concern. Importantly though, as leveraged as these companies are, the imminent risk of bankruptcy is not particularly high. Each company has received debt covenant waivers and amendments and/or issued longer-term bonds to refinance shorter-term debt.
Is Walter Energy a buy at $5 a share?
Walter Energy needs one thing and one thing only. The coking coal price needs to move higher. So far, that is not happening. The quarterly benchmark price is pinned near $120 per tonne. Walter has done a decent job in lowering its costs in the face of these horrendous pricing levels. However, Walter's stock is not a buy unless one thinks that coking coal prices will rebound robustly in 2015. The key question is how much of a rebound is required fpr Walter not just to survive, but to thrive.
I think a low-vol coking coal price of $170-$180 per tonne by mid-2015 would allow Walter's stock to double within one year. To be clear, I'm not predicting that coking coal prices will reach that level anytime soon; it could be years, not quarters, before we see those levels. Most analysts that cover U.S. coal producers expect a long, slow recovery in prices. A price of $150 per tonne by year-end 2014 would be a pretty good outcome, but far from assured.
What to watch for...
Investors should keep an eye on three things: production, costs, and pricing. There's a chance that Walter could lower per tonne costs by another $5-$10 in coming quarters. This alone will not make or break the company. However, if Walter can continue to lower costs and ramp up production, then the cash flow from operations could better support the debt load, making the overall valuation of Walter attractive again. For the time being, even though the stock is down from $141 to $5, there's no clear catalyst to buy it.
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