As Coal Companies Struggle, Walter Energy's Future Looks Bleak

| About: Walter Energy, (WLT)

Summary

Global met coal conditions will stay weak in future.

Walter Energy’s earnings and cash flow outlook seem bleak, and it is running out of options to stay functional.

Its stretched balance sheet and met coal market collapse continue to remain major headwinds.

High production has created a glut in the market, and has kept prices low.

The company’s depressed valuations are justified because of the market collapse.

The global met coal market is expected to stay weak in 2015, as the market fundamentals are weak. Slowing Chinese met coal consumption and high met coal supply have been negatively affecting the met coal market. In recent years, met coal demand has been slowing down while supply has been strong, which has created a glut in the met coal market and has kept prices weak. Going forward, I do not foresee any noticeable improvement in met coal prices, therefore, the performance of U.S. met coal miners like Walter Energy (NYSE:WLT) and Alpha Natural Resources (ANR) is expected to remain challenging. At present, given the difficult coal market conditions, U.S. coal miners are working hard to support their earnings. Also, the miners are working to improve cash flows and strengthen the credit outlook through productivity improvements and credit amendments, as the balance sheets of U.S. coal miners are stretched. However, despite the prudent efforts to improve performances, U.S. coal miners will continue to burn cash in upcoming quarters.

Walter Energy is among the leading met coal companies in the U.S. Walter's stock price has dropped by more than 99% since 2011. Due to the met coal market collapse and highly leveraged balance sheet; the company has a significantly high debt to equity ratio of 11.15x. Due to the collapse of the met coal market, the company's margins have dropped significantly, and its cash flow and earnings outlook seem depressed. WLT has been working to improve productivity, cutting its capital expenditures and making credit amendments to enhance credit strength and keep the company functional until a coal market rebound. However, in my opinion, WLT has been running out of options to keep the company functional due to a coal market collapse. The company might announce a sale of some of its assets to boost liquidity, which will only be a short-term positive for the stock. The company has completed only $25 million of asset sales under its $250 million asset sale target, and is expected to provide an update on its asset sales plans in upcoming quarters.

The met coal market has collapsed in recent years because of weak demand and high supply, which have resulted in a significant drop in met coal prices. The chart below displays a consistent drop in the met coal price since 2011.


Source: SNL.com

The slowing down of the Chinese economy remains a major reason for the met coal market collapse. Chinese met coal imports growth has been slowing since 2012. Also, going forward, China's GDP growth is expected to stay weak, which will keep pressure on the met coal market; China's GDP growth for 2015 is expected to be 7%, which will be the lowest in the last two decades. Moreover, the slowing steel production does not bode well for met coal demand; global steel production for the first two months of 2015 has dropped by 1.5%. The figures below show slowing Chinese real GDP growth and met coal imports.

Source: economist.com


Source: Bloomberg and doyletradingconsultants.com

Separately, met coal miners have not responded prudently to the drop in met prices by cutting supply. Despite the weak demand and low prices, supply has remained strong, which has created a glut in the market. The Australian supply has stayed strong in recent years, motivated by the Australian dollar's softness versus the U.S. dollar. Since December 2014, when the 1Q2015 met coal price was determined, the Australian dollar depreciated by almost 8%, whereas the met coal price for 2Q2015 dropped by 6.4% quarter-on-quarter, implying a slight price gain for Australian producers in 2Q2015 quarter-on-quarter, and will encourage Australian production to stay high, keeping the market oversupplied. The figure below, provided courtesy of Sterne Agee, reflects that the met coal revenue per ton for Australian and Canadian miners has been increasing since mid-2014, despite a drop in the met coal benchmark price because of a strong U.S. dollar.

The chart below shows the growing global and Australian met coal supply in recent years.

Source: Source: Bloomberg and doyletradingconsultants.com

Because of the met coal market collapse, Walter's earnings and cash flow outlook seem bleak. The company has been cutting its capital expenditures to protect liquidity, but I believe it will continue to burn cash, and is running out of options to keep the company operational. The company has total liquidity of $625 million, and without potential asset sales, I expect Walter to exhaust the present liquidity by mid-2016. The chart below displays the free cash flows and capital expenditure for Walter.

Source: Company reports and forecasts

Final Words
The global met coal conditions will stay weak in the future. Walter's earnings and cash flow outlook seem bleak, and it is running out of options to keep the company functional. The stretched balance sheet and met coal market collapse continue to remain major headwinds. I do not foresee any significant improvement in met coal prices as demand stays weak, mainly due to slowing Chinese coal imports. Also, high production has created a glut in the market, and has kept prices low. The stock is currently trading at a depressed price-to-book value of 0.2x. Depressed valuations are justified because of the market collapse. The following table shows that stock valuations have contracted in recent years due to the market collapse.

2010

2011

2012

2013

2014

TTM

Price-to-book value

11x

2x

2.2x

1.4x

0.4x

0.2x

Source: Morningstar.com

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Tagged: , , , Industrial Metals & Minerals
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here