Walter Insiders Bet on a Coal Turnaround

 | May 10, 2013 | 5:00 PM EDT
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It's been a tough couple of years for coal companies, whether they produce metallurgical coal (which is used to make steel; macro conditions have resulted in low steel demand), thermal coal (which is being outcompeted by cheap and plentiful natural gas) or both.

Walter Energy (WLT) is down over 60% in the last year, and hit its 52-week low in early May despite first-quarter losses being smaller than expected.

A number of insiders, including company CEO Walter Scheller, have reacted to the market's pessimism by buying. Scheller himself directly acquired almost 8,600 shares on May 6 at an average price of $17.57. We've also tracked purchases by the CFO and the General Counsel (among others).

Insider purchases are often seen as bullish signals since these individuals are incentivized to diversify their wealth rather than increase their company-specific risk, and so purchases (particularly purchases by multiple insiders) should only happen when there is confidence in the company's prospects. Studies back up a moderate outperformance effect for stocks bought by multiple insiders.

The stock has rallied in reaction to the news, and, as of this writing, Walter is trading about $1.50 per share above where the CEO was buying stock, though it's possible that it still has room to rise -- particularly if these buys signal a consensus for a turnaround in coal.

Revenue decreased by 22% in the first quarter of 2013 vs. a year earlier. Metallurgical coal volumes -- the vast majority of Walter's production is met coal -- were up by 17%, but this was offset by lower sales prices. Prices did tick up a bit on a sequential basis, and cost of sales per ton fell. Operating losses for the quarter came to $64 million, with Walter spending nearly that much over again on interest expense. Even with a sizable income tax benefit, the company recorded a loss of $0.79 per share.

Cash flow from operations was negative during the first quarter and has been poor enough over the past year that the trailing EV/EBITDA multiple is over 12x. Walter issued new debt during the quarter, allowing it to increase its cash position to almost $240 million. This should leave it in a good position cashwise for now -- together, operating and investing activities drained a little over $50 million in cash during the quarter -- but certainly the negative cash flow from operations is concerning.

Wall Street analysts expect this year to be a poor one for Walter Energy but for business conditions to then improve in 2014 to such a degree that the stock trades at 15x expected earnings for that year. A number of market players disagree with the sell-side's optimism, and as a result, the most recent data show that 15% of the outstanding shares are held short. We should also note that because steel (and therefore the metallurgical coal use to produce it) is tied to the global economy, Walter's stock price is highly sensitive to movements in broader market indices with the stock carrying a beta of 1.9.

Certainly, without the insider purchases, we'd be strongly against buying Walter -- the company is losing money, cash flows are negative, and it is a commodity business with its prices exposed to macro conditions. Of course, we do have consensus insider purchases, and that's always worth noting, but we'd say that, even at best, investors should wait for more information before buying stock in Walter.

A more important takeaway, perhaps, would be the implication that the CEO and other company insiders believe that coal prices will rise -- otherwise it's difficult to understand from where their optimism could come. Their opinion could then be weighed against other information that investors have access to when evaluating the coal industry more generally, including coal companies that are in a more stable financial situation but would still be able to capitalize on higher prices.

-- Written by Matt Doiron and edited by Meena Krishnamsetty.

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