Maybe Dmitry Balyasny’s Balyasny Asset Management expects Santa to have a long naughty list this year, but more likely it expects steel producers like United States Steel Corporation (NYSE:X) to start ramping up demand for metallurgical coal. The fund had doubled the size of its position in Walter Energy, Inc. (NYSE:WLT) during the third quarter of 2012 to a total of 2 million shares, which had made the stock one of its five largest holdings by market value at that time (see more of Balyasny’s favorite stocks). Now, according to a 13G filed with the SEC, the fund owns 3.4 million shares of the stock giving it 5.4% of the total shares outstanding.
Walter Energy is down 54% year to date- including a 27% decline during the third quarter, and another 10% fall since the beginning of October- so the fund appears to be doubling down on its investment. We know that Balyasny tends to be a more macro-oriented investor, so it’s likely that his fund is buying the stock because of bullishness on its industry rather than company-specific factors. We’d note that according to the fund’s 13F it had owned shares of other coal companies including Peabody Energy Corporation (NYSE:BTU) and Cliffs Natural Resources Inc (NYSE:CLF).
Revenue was down 11% in the third quarter compared to the same period in 2011, as weaker macro in Europe and Asia hurt demand for steel. Steelmakers are a primary source of demand for metallurgical coal, and so prices of the commodity are much lower than they were last year. A $1.1 billion impairment of goodwill gave the company an enormous net loss- Walter Energy’s current market cap is only $1.8 billion. With many expenses up, even excluding that writedown the company only had $35 million in operating income for the quarter versus about $530 million a year earlier.
Balyasny had been the largest holder of Walter Energy stock at the end of September according to our database of 13F filings. While Renaissance Technologies- a large hedge fund whose founder Jim Simons is now a billionaire- had added shares to its own portfolio (check out more of Renaissance Technologies’ stock picks), many other investors that we track had been more bearish. Billionaire Steve Cohen’s SAC Capital Advisors cut its stake, while Leon Cooperman and Glenn Dubin sold out of their positions entirely. The general community of traders doesn’t appear particularly optimistic either, as 11% of the shares outstanding were held short as of the most recent data. Sell-side analysts project $1.36 in earnings per share for 2013, which places the current stock price at 21 times forward earnings estimates.
Cliffs is probably Walter’s closest peer as that company focuses on metallurgical coal (and iron ore) as opposed to thermal coal for use in power plants as many other miners do. Cliffs carries a forward P/E of only 9, though its revenue has been decreasing at a much faster rate. While it’s an even more popular target for short sellers, SAC has been buying shares and Tiger Cub Philippe Laffont’s Coatue Management initiated a position during the third quarter (find more stock picks from Coatue Management).
Other coal companies who produce both steam and metallurgical coal include Peabody, CONSOL Energy Inc. (NYSE:CNX), Alpha Natural Resources, Inc. (NYSE:ANR), and Arch Coal Inc (NYSE:ACI). Thermal coal is also out of favor as electric utilities shift toward natural gas, and so these stocks are all down over the last year. Peabody is the only one of these peers whose revenue was up in its most recent quarter compared to the same period in the previous year, though even in that case net income had collapsed.
It looks to us like investing in any of these coal companies would have to depend on expecting improvement in their business. We think that we could see natural gas prices moving a bit higher, but for the most part low prices- and therefore crowding out in the thermal coal business- is here to stay. We’re not as pessimistic on metallurgical coal, but of course steel demand is driven by growth in China and other markets and we’re wary of relying on a return to strong growth in the near future. It seems to us like it might be a better idea to go long other basic materials stocks with strong exposure to China whose industries aren’t struggling as much thus far, such as Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX).