Walter Industries (NASDAQOTH:WLTGQ) materially increased its exposure to metallurgical coal just as that market was peaking. Now, with that specific sector of the coal market struggling, Walter is looking to close mines. And it isn't going to get any easier for this heavily indebted miner.
A transformational acquisition
Walter Energy agreed to buy Western Coal in 2010 for over $3 billion. At the time, the company claimed the acquisition, "Creates the Leading, Publicly Traded, 'Pure-Play' Metallurgical Coal Producer Globally." When the deal was consummated the following year, Chairman Michael Tokarz said, "We have truly transformed Walter Energy once again."
Since that time, however, the metallurgical coal market has changed -- a lot! Walter has since written off well over $1 billion of that cost. Clearly, the timing was off and shareholders took it on the chin. And, with the debt the deal added, the capital structure is now heavily weighted toward bond holders. Long-term debt makes up about 80% of its capital structure.
Worse, Walter recently refinanced some debt at higher rates and with the inclusion of a payment in kind provision. That's the sort of thing you include, for an extra cost of course, when you think you might need to pay bond holders with more debt because you just don't have the cash. Clearly, buying Western Coal transformed Walter in a big way.
No letting up
And there's no sign that the met coal market is going to help Walter out. For example, Natural Resource Partners (NYSE:NRP) recently gave a quick overview of the met market. And this April update was all bad: "Prices at lowest level in several years," "Market is currently being overproduced," and "Australian coal is more competitive in global market due to currency exchange rates."
Walter and Natural Resource Partners are basically North American miners (Walter has two UK mines). That means that 2014 should be another difficult year for this pair on the met front. In fact, Natural Resource Partners cut its dividend by 36% because of the expectation of continued coal weakness. Met makes up about 25% of Natural Resource Partners' top line.
Steel making coal makes up around 85% of Walter's coal sales. If Natural Resource Partners' met-market review is even remotely close, Walter has much bigger problems ahead of it. No wonder the company is making changes. In addition to the debt issuance, Walter just announced plans to shutter two mines in Canada.
According to CEO Walter Scheller, "These coal reserves remain valuable assets. However, given the current met coal pricing environment, our best course of action at this time is to idle these operations until we can achieve reasonable value from these reserves." In other words, Walter's got a met coal problem and it isn't going away in 2014.
Too much of a good thing
The funny thing is that steel demand has been heading steadily higher in recent years. But it isn't a demand issue, it's supply. Too many miners are chasing the met market. For example, last year equipment maker Joy Global (NYSE:JOY) noted in a quarterly conference call that its sales indicate that even more met supply is scheduled to come online in 2014. And that coal will be brought up with the most modern and efficient equipment, too.
Walter is, in the end, making the right moves to ensure it survives a difficult met coal market. However, the company clearly has too much met exposure at exactly the wrong time. With competitors like James River Coal falling into bankruptcy, heavily indebted Walter looks like a risky play, at best. The recent mine closure news does nothing to help improve that view. For these reasons, now is good time for you to pass on Walter Industries. If you like turnarounds, consider a far more diversified company, Natural Resource Partners, instead.