Owning shares of Walter Energy (WLTGQ) so far this year has been the financial equivalent of getting repeatedly hit in the head with a sledgehammer. Shares are down over 69% to date in 2014, but that is just the beginning of the pain. If you owned shares more than 15 years ago, even on a total return basis you would be reporting a net loss.
So why is Walter Energy in so much pain lately? And is this just the bottom of a cyclical industry? Let's look at how the metallurgical coal producer got into the position it's in today and whether there is any promise for the company in the near future.
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Live and die by the commodity curse
One reason Walter Energy has taken such a sharp dive recently is that the company has completely tied itself to the metallurgical coal market. Between 2009 and 2011, the company divested many of what it considered to be noncore assets and made a $3.3 billion acquisition of Canadian metallurgical coal producer Western Coal. That left Walter as a pure play on delivering metallurgical coal for the steel industry. With the developing world's hunger for steel growing by the day, metallurgical coal prices were soaring. According to the U.S. Energy Information Administration, the declared monthly export value for coking coal was at a very healthy $198 per ton.
Since that time, though, the combination of waning demand and several new mines coming online has sent coking coal prices crashing. As of the last quarter, those same monthly export values dropped all the way to $101.
At these plummeting prices, Walter Energy has been forced to shutter all operations at all mines it acquired in the Western Coal deal and is barely turning a gross profit on its current operations. Gross margin on all coal operations was a paltry 14% in the last reported quarter, which resulted in a $17 million quarterly loss on an EBITDA basis.
The creditor cat and mouse game
Things might not be so bad If Walter was simply suffering from a weak price environment. After all, coking coal is a commodity and is likely to suffer price swings. The larger issue, though, is that the company picked quite possibly the worst time to purchase Western Coal. Walter Energy took out sizable loans to cover some of the costs, and managing its debt has been a bit troublesome over the past several quarters.
First off, its debt profile is a quite sizable $3.2 billion today and gives the company a ghastly debt-to-capital ratio of 68%. As part of the credit agreement in the Western Coal deal, several financial covenants kept the company in check. This past quarter, though, Walter Energy did not meet some of those covenants. As a result, it was forced to take out a $320 million loan in July and its revolving credit facility availability was cut from $313 million to $76 million, leaving Walter Energy very little breathing room without taking on more long-term debt. None of that debt actually matures until 2018, leaving plenty of time for the market to turn around; however, the company still needs to generate enough in EBITDA to shell out about $80 million per quarter to service that debt.
Given its low EBITDA numbers and the minimum capital expenditures the company needs to spend to keep its operations running, Walter Energy could burn through cash pretty quick under current market conditions. Based on the company's current cash hoard -- about $612 million -- it can weather the storm for a while longer, but how long will depend greatly on where prices for coking coal go in the next several months.
What a Fool believes
The metallurgical coal market in mining is like watching a game of chicken right now. More than half of the world's coking coal capacity loses money at today's prices, but many companies are still producing in hopes of a market turnaround.
Source: Walter Energy Investor Presentation via Bloomberg Industries.
This actually makes for a conundrum for Walter Energy. On the one hand, it has some of the world's lowest-cost coking coal mines here in the U.S., but its financial situation is questionable given those debt obligations. To make matters even more difficult, many of its competitors in coking coal are giants of the steel supply industry; these include Glencore Xstrata and Vale, both of which are diversified into other business segments that give them their own respective advantages in weathering the storm.
Looking long term, the metallurgical coal market will pick up. It's a cyclical industry, and despite the push in the U.S. for steelmaking using natural gas instead of coking coal, coking coal will likely need to be used for many years to come to supply economic growth through steel production. The biggest question for Walter Energy is when that turnaround will take place. If this lull is sustained for an extended period of time -- a year or more -- Walter could be in a whole lot of financial pain.
