Investing In Coal



It doesn’t look that dirty…

Hey look guys, it’s a post on investing in coal, a sector so beaten up that victims of the mob pity it. I’ll never be a mob guy, but I think I’ll start telling people that I’m in waste disposal. That’ll make me a badass.

Specifically, one of my readers asked me about Walter Energy (NYSE: WLT), one of the largest coal producers in the U.S. It currently trades at a hair under $5, which is the lowest it’s been since the mid 1990s. I’m intrigued, so I figured I’d take a broader look at investing in coal.

But first, Walter Energy. Because hey, some guy with the last name of Walter, we remember you.

Upon a quick look at the balance sheet, it’s obvious the company has a debt problem that compares to the average debt blogger.. The current debt to equity ratio is north of 50%, which to any contrarian investor is a huge red flag. It owes more than $2.9 billion on equity of just $5.6 billion. That’s… bad.

Immediately, my first thought is the company is headed for bankruptcy. And upon further digging, I’d say the market agrees with me. The company’s 2020 maturing bonds have a 22% yield to maturity, even though they had an original coupon of ‘just’ 10%. The company isn’t on its death bed just yet, but the vultures are beginning to circle.

The good news? None of the debt matures until 2019, at the earliest. And even then, there’s only $350 million due. The heavy lifting doesn’t start until 2020, when the company is forced to either repay or refinance $1.35 billion in debt. That’s gonna be rough.

I’m too lazy to look, but there’s gotta be some debt covenants this company is getting close to breaking. Covenants are sort of mini contracts inside of the debt obligation that trigger a default if a company were to break them. Usually they cover things like debt to equity ratio, or something called debt coverage ratio, which essentially measures whether the company is capable of paying creditors.

I’d avoid it, because there’s just too much debt. However, I’ll admit there’s some major upside in the name if it recovers. It could easily be a $20 stock if the prices of coal double.

Which brings us to the second reason this stock is so beaten up, the price of coal is in the crapper.

There are two different kinds of coal – the kind that’s burned to produce power, and the kind that’s burned in the production of steel. Walter sells most of its coal to the steel industry, which, up until about a year ago, was a good business because of China. Now that the country has slowed down, so have prices.

I’m bearish on China for one simple reason. It’s in a credit fueled bubble. There is no way I’d invest a nickel in the country directly as this point. The nation created enough economic stimulus in five years (from 2008 to 2013) to recapitalize the entire United States banking system – about $1.5 trillion worth of it. The country went on a credit fueled orgy of construction, building entire cities that now sit empty. And most of it isn’t reported by Chinese officials because it was all quasi-government entities that did all the lending.

Coal needs a fresh new bull market in steel to recover. It’s not going to get it, at least not any time soon. And certainly not from China.

Besides, Walter’s operations are just too damned expensive. It made a slight operating profit in 2012 (before write downs), and didn’t even get close to breaking even in 2013. And this was when metallurgical coal prices were much higher. It’s working on bringing costs down, but still has a ways to go to even sniff profitability.

I spent an hour or so the other night trying to find an alternative to Walter, and I really couldn’t. The coal miners who actually have production and a solid balance sheet haven’t sold off as much. And there are plenty of small companies that trade at right around book value that, y’know, don’t actually produce any damn coal. There just isn’t much to choose from when you’re investing in coal.

The best solution I can come up with for investing in coal is Teck Resources (TSX: TCK.B), which gets about half its earnings from the dirty fuel.

Teck isn’t exactly in contrarian territory quite yet, but is getting close. The current price is $23.61, and the company has spent time regularly over $40/share before. The company has a better amount of debt ($8 billion to equity of over $18 billion), which excludes the $2.4 billion in the bank. It trades at a 20% discount to its tangible book value, and unlike Walter Energy, actually makes money.

Teck is a far better place to hide while you want for coal prices to recover. I’m not really interested until it gets a few bucks cheaper, but it’s a far better choice than Walter. There’s a small chance Teck goes bankrupt, but only after years of a crappy coal market. There’s a very real possibility that Walter goes bankrupt within the next couple years.

Anyway, I’d avoid the whole sector. It’s plenty contrarian, but there aren’t a lot of companies in the space with clean balance sheets. Too much debt makes me nervous, especially during a turn around.

Want To Invest In Payday Loans?

Because I spend hours and hours scouring the internet instead of doing anything productive, I’ve discovered a Canadian way to invest in payday loans. And no, I’m not talking about lending your buddy $50 for smokes and booze until next week. Besides, he’s not going to pay you back. You suck.

I know, I know. We all think payday loans are bad, and dumb, and worse than a Suze Orman endorsed prepaid credit card. And obviously, I’m not encouraging anybody reading this to go out and borrow money from one of these companies. They are the financial equivalent of heroin.

(Related: How to invest in weed)

But, saying that, I think people who smoke cigarettes and overindulge in alcohol are a special kind of stupid too. Both of those things are detrimental to your long term health, and really shouldn’t be done by anyone. Just because I think something is dumb doesn’t necessarily mean I don’t support your right to do stupid things, especially when those stupid things hurt only yourself.

So with that being said, I would have no problem plunking down some cash to invest in payday loans. Let’s see how.

In Canada, there is one publicly traded payday loan company, Cash Store Financial. The company was founded approximately a decade ago, out of Edmonton, and has quickly grown to over 500 locations across Canada, under the Cash Store and Instaloans labels. Close to 200 of these locations are in Ontario, which will become important in a minute. They also have a UK division, which is up to 25 stores.

The stock has struggled lately, as a bunch of factors have caused it to fall. The company was acting as an intermediary between customers and a Canadian bank, (DC Bank, to be precise) letting the bank take the credit risk. The bank was charging for this, obviously, and the company thought they could do a better job themselves. So they took a charge, severed the contract, and then borrowed a bunch of money to eventually be lent to dirtbags. This increased The Cash Store’s financial risk, which the market didn’t like.

And then, the company announced their dividend would be eliminated, at least for the time being, but in an odd way. Instead of releasing a statement, management just mentioned it on the conference call. Google Finance still thinks they pay a dividend. They do not. They’re also closing non-performing stores, and year over year revenue isn’t increasing.

And then, the big whammy. The Province of Ontario announced they were issuing a proposal to shut down the company’s operations in Ontario. The reason? In Ontario, the company can only charge a maximum of 21% for a loan, which includes interest and all fees. So the company does. What’s the problem?

Even though it’s called The Cash Store, the company’s business model involves zero actual cash. Everything is done electronically. If you get a payday loan with them, they put that money in your bank account. When it’s time to pay up, they take that money from the borrower’s account, just like any regular bill payment. This is all fine and good, except sometimes the money isn’t there. (remember who we’re dealing with here) So they charge the borrower an NSF fee, which pushes the cost of the loan above the legal limit.

The company has responded to the province. They plan to fight, and so on. They’ve also responded by no longer offering payday loans in Ontario. They offer lines of credit now, which are totally different than payday loans. How? Instead of having to pay it back by your payday, you now get two paydays to pay it back. It’s the payday loan version of putting two googly eyes on your cat’s ass and calling it a whole new animal.

The company is fighting the province’s desire to kick them out, but I’m not sure they’re going to win. Offering a line of credit that’s barely different than a traditional payday loan isn’t going to please the regulators.

Let’s look at the worst case scenario, which is the company getting kicked out of Ontario. They currently have 511 stores open, around 180 are in Canada’s biggest province, or 35%. Revenues would fall from $187M to $121.5M. The company lost money last year, approximately $3M once you take away the $40M charge they took when they severed their relationship with DC Bank. They’ve had several bad quarters in a row, they haven’t posted a profitable quarter in nearly a year.

The balance sheet isn’t great either, thanks to the $130M the company borrowed. They also have a lot of goodwill and intangible assets on the books, something no value investor likes to see. There’s very little in real assets the company can sell if things start to go badly.

Anyway, I’m getting bored. You anti-payday-loan people will be happy. Buying shares in The Cash Store is not a good way to invest in a title loan company. Although these people should probably know that I’d have no problem buying shares if the company’s fundamentals weren’t so bad.