Walter Energy: Investors To Remain On The Sidelines

Jul. 9.13 | About: Walter Energy, (WLT)

The political administration in the U.S. has been advocating against coal in efforts to address climate change concerns. The attitude of the administration has contributed to the underperformance of the coal industry in comparison with the market. Other factors that have contributed toward a downturn for coal are economic crisis in the eurozone and China, and the coal-to-gas switch by electricity producers. My subject company for this article is Walter Energy (NYSE:WLT), which is primarily focused in the met coal business. The company is the among the worst affected coal companies and its stock price has lost 71% year to date. Despite the plunge in the stock price for WLT, it seems problems are not disappearing for the company, at least in the near term.

The slowdown in China and the euro crisis have led to weak demand and prices for met coal. Due to ongoing sluggish coal markets, the international quarterly met coal benchmark settled at $145 per ton for Q3 2013. The benchmark price for Q3 '13 took a drop of 15% from the Q2 '13 benchmark price of $172 per ton. The benchmark price of $145 per ton is the lowest since the quarterly benchmark was adopted. Given the weak met coal prices, a production cut is expected by met coal producers in the U.S. and Canada to help rebalance struggling global met coal markets. WLT, Arch coal (ACI) and Alpha Natural Resources (ANR) are among the U.S. met coal producers that could cut their production; these companies have already lowered their production in response to weak market conditions, last year. However, in order to effectively address the problem of excess supply, additional cuts are required. Once the met coal producers address the problem of oversupply in the markets, coal prices are likely to recover by the end of 2013.

WLT is expected to lower its coal production by 6% in 2013, as compared to 2012. Also, in efforts to support its bottom line, the company has been working to improve upon its cost of production. The cost of production per ton is expected to be reduced by 15% this year, 2013.

Other than weak met coal pricing concerns as discussed above, the company is exposed to debt refinancing problems. The company has a highly leveraged balance sheet with debt to equity of more than 250%, which remains as a serious risk for the company. Last month, WLT declared that it will not proceed with a refinancing of a proportion of its existing debt. Also, S&P credit rating agency has placed WLT on credit watch after the company disclosed its refinancing plan. Now, WLT is expected to go for a credit amendment to comply with its debt covenants. However, uncertainty prevails over the refinancing issue in the near term and is likely to remain an overhang for the stock.

Given the weak met coal market conditions and uncertainty in regard to the debt refinancing plan, I will recommend investors remain distant from WLT. Once the company addresses the problem of debt refinancing, and meanwhile, coal markets and prices improve, WLT could be an attractive investment option for the investors as coal stocks are trading at depressed valuations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.