Will This Coal Miner Stop Falling?

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sometimes luck turns away from certain industries. This has been the case for coal miners this year. Prices for coal remain low. Despite all the efforts to reduce costs, coal stocks continue to suffer. The worst performer in the group is Walter Energy (NYSE: WLT). This stock is down more than 57% this year. Will fortunes change for this troubled miner?

Why Walter Energy is down so much

Walter Energy under-performs its peers. Arch Coal (NYSE: ACI), Alpha Natural Resources (NYSE: ANR) and Peabody Energy (NYSE: BTU) are down 32%, 34% and 29%, respectively. The reason for this difference is simple--Walter Energy is a pure met-coal play, while others produce thermal coal as well. Met coal is down together with iron ore and steel prices. Weakness in Europe, a slowdown in China and excessive supply cannot push prices in the upward direction.

The recent news was not positive for Walter Energy either. Moody’s downgraded the company with a negative outlook. The ratings company stated that the situation with supply and demand would not support price increases for met coal for at least a few quarters.

Raymond James cut its 2013 and 2014 met-coal price forecasts. It highlighted the same things: there is a lot of supply, but the demand does not grow. The company downgraded Arch Coal, Alpha Natural Resources, Peabody Energy and Walter Energy.

What can be done?

Walter Energy has stated that it has begun exploring options to refinance a portion of its existing debt in order to increase its financial flexibility. Debt is a problem for Walter Energy. It owes $2.6 billion. The debt was taken to finance the purchase of Western Coal. Looking behind, this was not the best decision.

The company acquired additional production capacity and debt. Then met coal prices started to fall. Walter Energy would be better off without excess production capacity and without debt. Unfortunately for the company, it needs a time machine to change that. Refinancing could be a smart move, if the company is able to get affordable terms.

Walter Energy has had success in reducing costs. Cash costs of sales were improving from quarter to quarter. This is surely positive for the company, but at current prices, it is not enough to change the fate of the stock. Walter Energy needs higher met coal prices.

Are other coal miners better?

When natural gas prices went past $4 to $4.50, hopes started to emerge for thermal coal. As of now, natural gas is once again trading below $4. Cheap natural gas makes it harder for thermal coal to fight for consumers. In addition to that, thermal coal is not environmental friendly and faces constant pressure on this front.

The prospects for miners who have thermal coal in their portfolios is bleak too. Only Peabody Energy is expected to end the year with a profit. The stock is trading at a 13 P/E, but it is hard to predict whether the company will meet estimates or not. In addition to that, estimates are constantly revised. During the last 90 days, estimates for Peabody’s full-year 2013 performance have fallen by 70%.

Just like Walter Energy, Peabody has been focused on costs. The main success came from its Australian unit, which managed to reduce costs by 10% in the previous quarter. Ironically, Australian production is one of the sources of excess supply on the market, which hurts coal miners.

Arch Coal and Alpha Natural Resources are expected to post a loss in the next two years. The stocks are trading at cheap prices based on their P/B ratios. Arch Coal trades at 0.3 P/B while Alpha Natural Resources trades at 0.2 P/B. The fate of the stocks is in the hands of coal prices too. Without the improvement on the pricing front, these stocks would perform badly.

Arch Coal is focused on the thermal coal market. Thermal coal is losing its ground in generation. Its share accounts for 40% of total generation, while it was 50% just five years ago. Given this fact, Alpha Natural Resources has switched its strategy toward met coal. This is an interesting strategy in the long term. But in the short term it presents additional risks, as met coal prices are under more pressure than thermal coal prices.

Bottom line

Walter Energy could not find support, and its stock continues to fall. The company depends on the price of met coal. Internal improvements can diminish the impact of low prices, but cannot solve the problem. Walter Energy pays a dividend that yields 3.3%, but the stock is too dangerous to consider buying it for the dividend. The stock is volatile and I expect it to stay volatile in the near term.

There are two ways that met coal prices could rise. Either the macroeconomic situation improves and demand picks up, or players begin to exit the business and supply shrinks. The latter looks to me more plausible. If Walter Energy survives this hard time, it would be an attractive company with good costs and a splendid asset base. But for now, it’s just too risky to invest in. 

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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