Will The Bloodbath Ever End For Walter Energy?

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

Walter Energy (NYSE: WLT) is a source of never-ending pain for its investors. The stock has lost 68% this year. When it seemed like all the bad news was issued, more bad news came.

Can Walter Energy survive this tornado? Let’s take a look.

Source of the problems

Walter Energy is a metallurgical (met) coal producer. Met coal prices have been under tremendous pressure. At current price levels, company is not able to become profitable despite all of its cost-cutting measures. The situation is deteriorating fast, and so is the stock price. Just 90 days ago Walter energy was expected to lose $0.79 per share this year. Now it is expected to lose $2.01 per share. Estimates for 2014 have been slashed by 98%, although they remain positive.

At the beginning of June, the company has announced that it was exploring options to refinance a portion of its existing debt. Walter Energy, which has a huge 2.76 debt-to-equity ratio, wanted to replace existing debt with debt that would mature further in the future. If this move were successful, it would have postponed possible liquidity problems.

Then things went the wrong way, and soon Walter Energy has announced that it is not going to proceed with refinancing. What does it mean for investors? The company explored the options and found that it cannot get acceptable terms. On the same day when Walter Energy released its refinancing intentions, Moody’s have downgraded its rating on Walter Energy with a negative outlook. It is highly possible that Walter Energy found that investors are ready to buy bonds that yield more than 10% and found such rates unacceptable.

More wood to the fire

At the beginning of June, Raymond James has cut its 2013-2014 met coal price forecast and downgraded Walter Energy, Arch Coal (NYSE: ACI), Alpha Natural Resources (NYSE: ANR) and Peabody Energy (NYSE: BTU). This move was met by analysts at Morgan Stanley, who stated that Walter Energy is too tempting to ignore. They said the stock could trade as high as $35.

This was probably the only bright point for Walter Energy. The latest statistics from China show that steel production in late May was down 4.7% compared to mid-May. Given that met coal is used for steel production, this is bad news.

In addition to that, US coal shipments fell 31% in April from the prior month. The main cause was the oversupply in Asia. The combination of this news was troubling for other coal stocks, and they accelerated their decline. Arch Coal is down 48% this year, Alpha Natural Resources is down 47% and Peabody Energy is off 43%.

As if all of the above mentioned was not enough for Walter Energy, Standard & Poor’s has placed all existing ratings on the company on CreditWatch with negative implications. The firm stated that Walter Energy was not able to refinance its debt and it raises concerns about the company’s liquidity.

The main concern

The most important topic in coal industry now is liquidity. If a company has enough cash, it can wait for coal prices to rise and survive the storm. Walter Energy had $235.7 million of cash and cash equivalents on its balance sheet at the end of the first quarter.

Alpha Natural Resources has stepped in and said it is confident in its liquidity position. The company would have to meet $417 million in debt obligations due in 2015. Alpha Natural Resources said it is not planning to issue more equity, stating it would have been a bad decision at current prices.

Arch Coal and Peabody Energy are also in a better liquidity position. Arch Coal possessed $730 million in cash and cash equivalents at the end of the first quarter, while Peabody Energy had $629.5 million. Walter Energy and Alpha Natural Resources have greater exposure to met coal, while Arch Coal and Peabody Energy specialize in thermal coal. Thermal coal situation is difficult too. The recent positive point was Obama’s speech on green technologies, where he did not say anything disruptive for coal industry.

Bottom line

Coal stocks get cheaper and cheaper. They are trading at attractive price-to-book (P/B) values. Walter Energy trades at 0.75 P/B, Arch Coal trades at 0.29 P/B, Alpha Natural Resources sells for 0.24 P/B and Peabody Energy sells for 0.82 P/B. The only question is whether the companies would be able to make it through the period of low prices and become profitable once again.

If you are considering adding coal names to your portfolio, make sure that you can afford the risk. In the case of Walter Energy, there is a possibility that you might lose your investment if the company goes bankrupt. At the same time, the stock could rise more than 200% if the company manages to stay afloat. This is an asymmetric risk/reward profile that many investors are searching for, but the amount of risk is huge.

Peabody Energy and Arch Coal have good liquidity positions and are definitely safer investments. More, they have exposure to thermal coal rather then met coal, which puts them in a stronger position. Alpha Natural Resources stated in its latest earnings call that it has plans to re-balance towards met coal production. Not the best move in the short term for sure, so I’ll advise to stay away from the stock.

If you want to bet on met coal, play big and choose Walter Energy. 

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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