As far as the metallurgical segment — Walter’s bread and butter — goes, demand has stabilized, albeit at lower levels. According to the U.S. Energy Information Administration, coking coal domestic demand for 2013 should slip about 1.4% from last year, to 20.5 million tons. Not a disaster.
Imports are a different story. Last year, import demand stood at 125.7 million tons. This year’s forecast is pretty grim at 107.1 million tons, a 14.8% drop. However, the 2014 forecast for coking coal imports appears stable at 108.4 million tons. A modest increase of just 1.2% leaves some room for an upside surprise.
As far as Walter Energy, Inc. (NYSE:WLT) is concerned, the picture, believe it or not, is getting brighter. Forget about 2013: Sales should come in at around $2.1 billion versus $2.5 billion last year, which would be an ugly 16% drop. However, forecasts for 2014 call for sales of $2.3 billion, which would be an impressive 9.5% improvement over 2013.
Cash flow is also improving. After a negative 98 cents per share last year, free cash flow has turned positive to about 48 cents per share. That’s expected to climb more than 170% next year to a projected $1.31 per share. The company will accomplish this through tighter capital controls and eliminating the dividend.
While I normally don’t like to see dividend cuts, this is necessary for the survival of the company and actually adds more value to a deeply undervalued stock.
Last, the hope of all stock investors: Walter Energy, Inc. (NYSE:WLT) is rumored to be a takeover candidate. Whenever certain sectors become depressed, consolidation often follows. Possible suitors have included Alpha Natural Resources, Inc. (NYSE:ANR), Brazilian miner Companhia Siderurgica Nacional (ADR) (NYSE:SID) and Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A). Based on the unlocked assets at Walter, that idea is right up the Oracle of Omaha’s alley.
Risks to consider: By its nature, contrarian deep-value investing is extremely risky. As an investor, you’re buying into an idea or event that may very well fail to materialize. As a business, Walter Energy is in a precarious position. One way to protect yourself would be to use a stop-loss order 15% to 20% below your purchase price. Another way would be to use options to hedge your long position. (My colleague Amber Hestla-Barnhart covered this in great depth.) Finally, the coal industry is depressed and very sensitive economically. Continued global economic weakness would likely suppress this idea.
Action to take –> Walter Energy is clearly undervalued, based on the company’s improving internals and improving macro conditions, a 12-month price target of $16 would bring the company back to its book value. Shares currently trade around $11.50. This would represent a 40% return. The annual 50-cent-a-share dividend gives the stock a yield of about 4.4%. Don’t count on it being that high forever, but this will help the company in the long run.
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