Walter Industries (NYSE:WLT) is a company that is not well understood by most investors, and I feel, trading at a level significantly below its intrinsic value. Because Walter operates in traditionally “un-sexy” industries and has a relatively poor record of profit generation, this company has flown under the radar screens of most Wall St. analysts and portfolio managers. Even after posting a 300% return in 2005 and growing its market value well into mid-cap land, the stock is still only covered by 2 lesser known brokerage firms.
In my view the company has some assets that most investors may not fully appreciate. Currently Walter operates 3 segments, a homebuilding division that manufactures and provides financing for low priced modular homes sold largely to customers in the Southeast, an industrial segment that makes ductile iron pipe, or the heavy duty pipe used in water distribution systems, and a coal mining division that operates 5 mines in northern Alabama. While the money losing homebuilding has traditionally captured all the headlines, effectively scaring away the “housing bubble” crowd, I am more focused on the value of the industrial and coal businesses.
Lets start with the industrial or water pipe business. Late in 2005 the company acquired privately held Mueller Industries, increasing the contribution of this segment to about 60% of sales and 50% of operating profit. The well publicized “water crisis” resulting from an aging U.S. water infrastructure has driven demand for Walter-Mueller products. Furthermore, Walter-Mueller has a significant competitive advantage in the location of its manufacturing; its New Jersey and California facilities are in close proximity to the areas of the country where infrastructure is needed most the fast growing sunbelt, and the metropolitan areas of New York, Philadelphia, and Boston, where current systems are over 100 years old. In Q4-05 these businesses generated roughly 75mm in EBITDA. If we do a simplified analysis and extrapolate this seasonally weak quarter, this segment has roughly 300mm in annual earning power. Most public companies is this space trade at roughly 8x EBITDA, implying that this segment is worth 2.4Billion
The coal business looks even more interesting. The type of coal that WLT mines is called metallurgical or “met” coal. This is the type of coal used in the steelmaking process, and strong demand, particularly from China is driving the price over the $100 per ton level, nearly 3x the price of its soft, high-sulfur counterpart “steam” coal that is used in power plants. During the most recent quarter WLT was booking average prices of about $99 per ton for their coal, but management was hesitant to comment on 2006 prices as coal contracts are currently in the negotiation process. The total cash costs of extracting this coal are about 52-54 per ton, implying about $48 in EBITDA per ton extracted. The company anticipates mining about 7mm tons in 2006, and production is expected to grow by more than 30% over the next 3 years. If these prices hold, it is feasible that the company could generate $326 in cash flow this year. Applying the coal industry average multiple of 10x, yields a value of this business over 3.2B
Ignoring the homebuilding business, which when coupled with its financing arm is generating a small and growing profit, these two businesses could be worth 5.6 billion. Subtract 1.5B in debt that is attributable to these operations, and we are left with 4.1 billion in value or $100 per share. While the analysis has been simplified, the stock trades at a significant discount (currently $65), and there is plenty of room for error here.
Lastly, there are several catalysts on the horizon. The company plans to break up the divisions eventually so that homebuilding, natural resources, and industrial, can hopefully earn the respect (and multiples!) they deserve. News-flow surrounding new coal contract negotiations could also provide a lift for the shares. Lastly, a high concentration of activist shareholders on the top ten owners list is sure to drive management to create value.