Is It Time to Buy This Met Coal Producer?

Is It Time to Buy This Met Coal Producer?

A pure met-coal play, Walter Energy has been under pressure throughout this year. In the past few months its shares have stabilized, and share prices did not change much even after the third-quarter earnings report. Is this a sign that Walter Energy's business has stabilized? I don't think so.

There are a lot of obstacles in front of the company, and the stock trades at 88% below the historic high that was reached back in 2011. Let's take a look to see if the company sells for cheap.

Another loss
Walter Energy posted a $100.7 million loss in the third quarter. The company has been struggling to be profitable since met coal prices started to plunge. Despite its desperate attempts to cut costs to achieve profitability, this target is still far away.

The report showed that a 16% improvement in met coal sales volume was offset by a 12% decline in the average net selling price. As a result, quarterly revenue rose only 3.2%. This improvement is not enough to make a significant difference.

The massive $2.7 billion debt continues to weigh on Walter Energy's performance. This quarter it led to a $63.5 million interest expense. Going forward, the quarterly interest expense would be $54 million. This is a hefty burden for a coal miner that struggles to make ends meet.

Oversupply remains a problem
Met coal market continues to be oversupplied. Walter Energy states that it expects global steel demand to rise 3.1% this year and 3.3% next year, but I think this will not be enough to improve the price situation for met coal. More supply is coming in than will be used. BHP Billiton has grown its met coal production by 14% in just one year, and has more projects on the way.

BHP Billiton plans to start production at its Caval Ridge mine in 2014. The mine will initially produce 5.5 million tons of met coal per year. It looks like the company is not afraid to put more coal into the market, and it is not alone.

Even Arch Coal , which is mostly a thermal coal producer, has announced plans to put more effort in met coal mining. The company plans to transition into a met coal play in Appalachia region. Arch Coal's decision is unlikely to be significant to the market, however. BHP Billiton produced 10.1 million tons in the third quarter, while Arch Coal expects to produce no more than 7.3 million tons in the whole year.

Debt weighs on Walter Energy
Walter Energy states that it expects met coal prices to improve in the fourth quarter. I don't think that this is a reason for much optimism. Excess production capacity is likely to pressure met coal prices. Let's turn instead to Walter Energy's liquidity, as it is extremely important in the current situation.

The company had $293 million in cash on its balance sheet at the end of the third quarter. That is not much if it's going to continue to lose $100 million per quarter. To improve its position, Walter Energy targets asset sale proceeds of $250 million. The company stated that it has made some progress on this front.

Even if Walter Energy is successful with this sale, its debt problem remains. It is very likely that the company will have to go to the debt market. In September, Walter Energy managed to sell $450 million of its 9.5% senior notes. Next time, the cost of capital would be higher should met coal prices stay on current levels.

Bottom line
Despite all of its problems, Walter Energy is trading slightly above its book value. I think that this is a reasonable price for the company. Walter Energy's position remains dangerous. There are two ways that it could be improved, however. The first is a rise in met coal prices, and the second is a further cut in costs.

The problem is that Walter Energy has already done a lot on the cost front. It is unlikely that we will see significant improvements there moving forward. That's why the company's future depends mostly on met coal prices.

Time is precious for Walter Energy. If met coal prices stay at current levels for another year, investors will be reluctant to buy the company's bonds. This could be a problem, since they are vital for Walter Energy's existence.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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