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Walter Energy Is Not Dead Yet!


If you can't turn it around, set up for a buyout.

Many say that King Coal is dead, and that coal companies are quickly becoming a thing of the past. Coal is still very much an essential piece of energy production and is critical in the production of steel (metallurgical coal). Coal stocks have been beaten up because massive amounts of natural gas have been found in the United States within the last five years. However, this has spilled over excessively into the cheapening of the metallurgical coal names. In particular, Walter Energy (NYSE:WLT) has too many things that are improperly discounted.

The Fundies

As I dig into Walter, I see free cash flow declining, assets falling, shareholders' equity declining, and margins that are horribly negative. So why in the world would I think this is a good stock? Let's dig a little further.

Operating cash flow has been increasing for the last three quarters, so why is free cash flow declining? The answer is Capital Expenditures (CapEx). Walter has been increasing CapEx in an effort to bring additional coal supplies online and to increase revenues. Additionally, we see a massive negative income in the last reporting period. Why? Looking at the balance sheet, we can see that there was a full impairment of the Western Coal acquisition. Walter basically decided to write off all the goodwill from that acquisition to clean up the balance sheet while not impairing the tangible assets at all. This explains the shrinking shareholder equity, declining assets, and negative margins, and it also looks like a "kitchen-sink quarter."

So why the massive changes to both the cash flow statement and balance sheet? What is it trying to accomplish? In my view, this screams of putting a company up for sale. In the energy space, buyouts are typically valued in one of two ways: 1) a value of proven mineral assets, or 2) a multiple of revenues. Writing off goodwill ahead of a buyout increases the chances of shareholders approving a buyout as it reduces book value to a more realistic number. As well, investing directly into revenue production rather than focusing on profitability can increase the final buyout number via increased revenues. What I see here is a company that's integrating an acquisition in order to leverage it for an opportunity to be acquired. I also see a company that is cheap on a price-to-sales ratio and has a current ratio over 1.5. Both of those measures are healthy considering it is a hurting industry.

The Chart

Walter Energy has had a tremendous time trying to get through the $40 level and has been rejected there five times in the last six months. Throughout those six months it has been consolidating under that level and is forming a nice inverse head & shoulders pattern. The measured move of that pattern would be in the $52-per-share range, and could extend up to the prior congestion/breakdown area of $62ish. My accumulation zone is anywhere between 33 and 38 if this shoulder needs more time, or I will wait for the breakout over $40.

The bottom line is, the fundamentals are not as ugly as they appear on the surface, the technicals are getting better and better, and it looks like they are hanging up the for-sale sign.
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