Walter Energy: A Distressed Opportunity?
I’m always looking for a big upside while trying to limit downside risk. (Who isn’t?) Which is why I find global deep value and “distressed” plays so interesting.
These stocks are trading far down from their highs and oftentimes well below book or breakup value. This always prompts the question: How much worse could it get?
When it comes to this stock, the answer is much, much worse.
Trouble in the Coal Industry
In the last year, Walter Energy Inc. (WLTGQ) has gone from $6.84 to just $0.08 per share and from trading on the big board to the pink sheets. In July, it filed Chapter 11 to try to negotiate its way out of a mountain of debt exceeding $5 billion.
What a fall from grace for this proud Alabama company that was once a leader in metallurgical coal production.
Walter Energy, known in the industry as Walt Coal, represents a stock and an industry that are both beaten down and ignored – in spite of the fact that coal provides 43% of America’s electricity and 43% of the world’s electricity.
Although the current Environmental Protection Agency would probably like coal to disappear, it’s not going anywhere anytime soon.
Walter Energy specializes in metallurgical coal that’s primarily sold to steel mills and used in the integrated steel mill process. The company sells to high-growth steel markets in Asia, South America, and Europe and also produces thermal coal, anthracite, and metallurgical coke and coal bed methane gas.
Before its recent problems, Walter Energy employed approximately 3,500 employees and contractors with operations in the United States, Canada, and the United Kingdom.
Unfortunately, both the company and industry face challenges with supply and concerns over global manufacturing and industrial growth. This has led coal prices to drop sharply – with the benchmark price down 50% since 2012.
Other big challenges are weak demand in Asia and Europe, high labor costs, Obama’s regulatory war on coal, and $265 million in debt service payments a year.
Struggling to Survive
The key question is this: Are we coming off a bottom in the coal cycle and, if we are, can Walter Energy survive long enough to get back in the game?
What might give the company some life?
Inside Coal reports that Walter Energy may be in talks about the potential sale of substantial assets. This is significant, since proceeds could be used to reduce debt – a key concern of analysts. The company recently refinanced some debt, lowering risk, but it remains significant.
On the other hand, if you can find catalysts to unlock the value or if the company becomes a buyout target, the upside gains can be extraordinary.
In particular, any uptick in Chinese industrial activity and imports of coal will help Walter’s prospects enormously. Senior lenders such as KKR, Apollo, and Blackstone are trying to restructure debt to avoid costly write-offs that will hit earnings hard.
The company continues to try to sell assets at reasonable prices and is negotiating with the United Mine Workers to trim labor costs.
Walter Energy is an aggressive trading recommendation with near-term prices closely tied to any signs that some sort of deal can be worked out.
For example, on October 16, it gained access to 30 days of cash to give the company some breathing room to strike a deal. This news sent the stock up 9.6% in one day.
It’s an opportunity that’s not for the faint of heart – that’s for sure.