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Walter Energy, Inc. (WLT): Classic Turnaround Play or Value Trap?

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Shares of Walter Energy, Inc. (NYSE:WLT) have been pummeled as of late. The metallurgical coal producer, one of the only pure plays in the industry, has not only been experiencing losses since 2012, but is now spooking investors of its long-term viability. In fact, one of the reasons for the stock’s 68% drop in share price so far this year was the announcement on June 14 that Walter Energy, Inc. (NYSE:WLT) would not be moving forward with a planned $1.55 billion credit refinancing. The shares promptly fell as S&P also announced the firm was now on credit watch due to the announcement. Given all the blood that’s running in the streets here, might there be opportunity?

Walter Energy, Inc. (NYSE:WLT)

Canary in a coal mine?

With the possibility that a purchase of Walter Energy, Inc. (NYSE:WLT) could be a falling knife in mind, what are the odds that Walter can return to some form of its former glory? Better than one might think. A pullback in an industry can often be a fantastic opportunity to purchase cheap shares in companies that have the ability to outlast the storm. Coal prices have sagged in recent years, for reasons ranging from a slowdown in Asia to a lack of breadth to the global economic recovery. As if sagging demand was not enough, Federal environmental regulators are not making things any easier for coal producers by increasing emissions standards for thermal coal’s main customers. On top of all this increasingly tough competition from plentiful natural gas reserves in the United States means coal producers should keep their eyes on their canaries as they head to work each morning.

A Tale of Two Coal Markets

Despite all of these negatives, Foolish investors have several reasons to look past any sickly canaries. First, unlike most coal producers, Walter Energy, Inc. (NYSE:WLT) is solely a metallurgical coal producer as compared to a thermal coal producer. Thermal coal producers have been under pressure due to competition from natural gas as power generators switch to a cleaner, cheaper fuel. Metallurgical coal producers don’t have this issue, with low prices for metallurgical coal being caused by sagging demand that will inevitably return with global steel production.

This compares with the issue being faced by thermal coal: potentially being entirely replaced by natural gas. Many other coal producers are seeing the writing on the wall: Alpha Natural Resources, Inc. (NYSE:ANR) which produces a mix of thermal (81% of output) and metallurgical coal (19% of output) recently announced a shift towards focusing more on metallurgical coal production. Holders of ANR will no doubt benefit in the future from this move, but any rebound in their metallurgical coal division will be diluted by the company’s continued presence in the thermal coal markets. This is what makes Walter Energy, Inc. (NYSE:WLT) worth a look: Foolish Investors looking to place a bet on the dichotomy between the futures of these two coal markets have little to choose from when looking for a pure metallurgical play.

The only other publicly traded entity besides Walter Energy, Inc. (NYSE:WLT) whose fortune is tied solely to the metallurgical coal industry is SunCoke Energy Inc (NYSE:SXC). SunCoke operates on a contractual basis with what amounts to just two clients, ArcelorMittal (ADR) (NYSE:MT) and AK Steel, thus benefiting from the inherent stability that goes hand in hand with long-term clients.  However this prevents SunCoke from benefiting in a large way from an eventual rebound in metallurgical coal prices. SunCoke Energy Inc (NYSE:SXC) also leaves much to be desired in terms of valuation: It currently trades for just under 2 times book value. Even SunCoke Energy Inc (NYSE:SXC)‘s own recently spun-off Master Limited Partnership (MLP) SunCoke Energy Partners LP has only a steady 7% dividend to offer investors. Decent for a MLP dividend stock but hardly eye-catching if one wishes to earn above average returns betting on an eventual turnaround in metallurgical coal.

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