With the average coal producer down ~65% from last year's high and global coal fundamentals still depressed, only one thing keeps me coming back for more......coking or, "met" coal. But, not just any kind, I'm talking about the premium low-vol brands produced by BHP, (BHP) Teck Resources, (TCK) Anglo American, (AAUKF.PK) and Walter Energy, (WLT). Only Walter, currently the 3rd largest producer of premium coking coal in the world, is a pure-play.
Low-Vol Coking Coal is the Best of the Best, Better Than the Rest
Low-vol hard coking coal is a truly scarce steel making ingredient. While coal is found in more than 60 countries, low-vol coking coal is only known to be accessible in relative abundance in Canada, Australia, China, Mongolia, the U.S., Russia, and Mozambique. Two additional countries that have low-vol resources and are trying to ramp up to meaningful scale are Indonesia and Colombia. This scarcity is reflected in the premium price obtained for low-vol compared to other coking coals.
Not only is low-vol coking coal the most scarce, but demand for it is the most stable because blast furnaces used in the process of steel making require a steady diet of low-vol coking coal. These furnaces use coking coal blends optimized to produce the best quality coke at the lowest price. End users blend a variety of coals from multiple sources so that if mother nature, labor disputes or transportation bottlenecks interrupt the supply of one coal, others can be substituted.
A key attribute in a blend that can't be readily substituted for is the volatility. That's because the blended volatility must be sufficiently low to ensure the efficient operation of the furnace, thereby minimizing maintenance costs. Therefore, demand for higher vol coking coals fluctuate due to rapid supply responses of the less scarce commodities. For example, the benchmark quarterly low-vol coking coal price is down about 32% from a year ago. However, the price hi-vol "B" coking coal, a mid-tier product, is down by about twice that amount.
Pure-Play Low-Vol Coking Coal Companies Are Hard to Find
Walter Energy's coal is among the best in the world. As a pure play producer, Walter is a prime takeout target. However, prospective acquirers seem to forget how compelling a target Walter is when coal markets are depressed, only to get fired up again when fundamentals rebound. Prospective acquirers should look to acquire Walter now, not after the stock price has doubled.
From time to time news hits the tape that a prospective acquirer is kicking the tires. Last year when Walter's stock price was in the $70's and $80's, speculation of a takeout seemed to surface once a month. Since then the stock price has been slashed in half and in fact is down 75% from last year's high. As Walter's enterprise value shrinks, the financial wherewithal of strategic acquirers grows. In addition to global miners, Brazilian, Japanese and Korean steel producers like Companhia Siderugica Nacional, (SID), Gerdau, (GGB), Nippon Steel, (NISTF.PK) and POSCO, (PKX) should take a serious look at Walter.
But the list doesn't end there. Global commodities traders including Glencore, (GLNCF.PK), Noble Group, (NOBGF.PK), Mitsubishi and Mitsui would gain valuable proprietary knowledge of seaborne coking coal markets. Although less frequently mentioned as a suitor, Walter would be an especially good fit for Vale, (VALE) as it would diversify and expand Vale's product offerings and customer base.
These Companies Would Greatly Benefit From Acquiring Walter
Vale: Based in Brazil, Vale is the single largest iron ore producer in the world. The vast majority of Vale's revenues and earnings come from iron ore. Walter has a significant and sustainable shipping advantage into Brazil. Vale has already demonstrated an interest in coking coal. It has a huge project in the emerging coking coal powerhouse of Mozambique. By the end of the decade, a combined Vale & Walter could overtake Teck to become the 3rd largest producer of low-vol coking coal in the world behind BHP/Mitsubishi and Anglo American.
BHP: The company, in a 50/50 partnership with Mitsubishi, is already the largest producer in the world. However, all of BHP's coking coal comes from the mature and prolific Bowen Basin in Queensland, Australia. An acquisition of WLT would provide instant geographical diversification, open up exports to Brazil and Europe and hedge against having so many coking coal eggs in one Australian basket. BHP's Japanese and Korean customers would appreciate the diversification away from flood and strike prone Australia.
Rio Tinto (RIO): Like Vale and BHP, Rio has a massive iron ore business. Iron ore is a tremendously profitable segment for Vale, Rio and BHP. However, unlike in coking coal where new projects are being delayed and canceled, iron ore development remains on track for very substantial increases. It's very possible that in coming years iron ore margins will be squeezed while margins on low-vol coking coal operations increase. Rio loves coal assets tied into the seaborne markets. That's why Rio is big in Australia and more recently Mozambique, (along with Vale). Walter's premiere low-vol coking coal assets in the U.S. and Canada would be a great fit for Rio's growing empire.
Teck Resources: Teck, like most global diversified miners, has attractive organic growth opportunities in premium low-vol coking coal. However, Teck will fall from 2nd place to third as Anglo brings on up to 15 million additional tons in Australia. And, if Teck allows WLT to be gobbled up by a larger peer, then Teck could find itself in 4th place. In an industry where size really matters, Teck should acquire WLT before Rio, BHP or Anglo does.
ArcelorMittal (MT): As the largest steel producer in the world and also with key steel making operations in Brazil, Mittal would benefit from additional vertical integration. MT already owns coking coal and iron ore assets, so this would not be a stretch for them. In fact, Mittal almost teamed with Peabody Energy, (BTU) in acquiring Australia's Macarthur Coal, but prudently pulled away when market conditions worsened. As a truly global steel producer Mittal should acquire WLT before POSCO or Nippon Steel does.
Freeport-McMoran, (FCX): A real wild card, I've never heard of FCX looking at coking coal assets, buy why not? FCX is a copper & gold play, but coking coal would nicely diversify Freeport's product offerings and geographic footprint. FCX is involved in a few high risk countries, most notably Indonesia. Walter's U.S. and Canadian assets would help mitigate overall country risk. Freeport's balance sheet has more cash than debt and the Company's trailing 12 month EBITDA was almost $8 billion.
A Brazilian Steel Producer, like SID or GGB: Brazil is a hot market for steel. It has vast iron ore resources, but little to no coking coal. Brazilian steel producers get most of their coking coal from Walter and a number of U.S. east coast players including Alpha Natural Resources, (ANR) and Consol Energy, (CNX). SID or GGB could lower input prices, secure supply and profit from sales of excess coking coal.
A Global Commodities Trader Like Glencore, Noble Group, Mitsuibishi or Mitsui: Glencore, through its pending acquisition of Xstrata, has demonstrated that it's an aggressive acquirer of assets. A combined Glencore and Xstrata would still have plenty of room to scale up in premium low-vol coking coal. Noble Group, Mitsuibishi and Mitsui each already have ownership stakes in multiple public and private coking coal companies.
I've outlined a handful of specific companies and indicated which type of companies should be interested in acquiring Walter Energy. I believe that all of the named companies have the financial ability to do a deal. In fact, global miners BHP, Anglo, Rio Tinto, Vale and Teck each have investment grade debt ratings and can access 10-yr fixed coupon debt at rates as low as 3%-4%. Walter's Enterprise Value is $4.5 billion, small enough for any of the named companies to swallow.
One thing that is known for certain is that a lot of companies have looked at Walter over the years. If a prospective bidder emerges, other suitors will be watching closely. News of a possible takeout could move WLT shares significantly higher like it did on September 7, 2011 when WLT shares were up ~20% from $75 to $91 and again 5 weeks later when WLT shares were up ~16% over a 2-day period.