The Rising Influence of Rising Affluence

[DewDiligence]

Could WLT Be BHP’s Plan B?

[The premise of this piece could also apply to a buyout of CLF, which has a major presence in North American met coal although it is primarily an iron-ore company (#msg-56398409).]

http://blogs.wsj.com/source/2010/11/10/bhp-should-implement-plan-b-for-acquisitions

›November 10, 2010, 1:41 PM GMT
By Edward Tan

Now that BHP Billiton’s bid for Canada’s Potash Corp. is a long shot, the Anglo-Australian miner would be better off looking for smaller deals that strengthen its core business.

One place to start is growing its metallurgical coal (met coal) presence in the Americas. A sizable acquisition target in that sector is Walter Energy, one of the purest metallurgical coal producers in the United States.

Walter’s high-quality coal makes it ideal for use by steel mills around the world, especially for those in Europe and Brazil. What’s more Walter is in the midst of searching for a chief executive, allowing the company’s board of directors to set personalities aside and focus on the merits of a transaction.

It takes about 34 days for Australian miners to ship met coal to buyers in Europe. The transit from Walter’s mines would take one-third of that time. Indeed, the U.S.’s 46 million ton capacity of met coal is only a third of what’s available in Australia, but it’s cost effective to ship from the U.S. to Brazil where coking coal demand is expected to reach 40 million tons in five years.

While Walter’s enterprise value of $5 billion would hardly dent BHP’s $12.5 billion cash hoard, Walter does have ongoing capex needs of $125 million; but its acquisition would offer a further launching pad for BHP to make other met coal acquisitions in the Americas.

With the completion of its Mine No. 7 capex, Walter has the largest met coal mine in North America, capable of producing 9.5 million tons by 2012 compared with about 7.5 million tons in 2010. Like Potash Corp., Walter is an operating company with a well-established production profile and marketing outlets. Walter’s low leverage — total debt to Ebitda hovers around 0.5 — gives it plenty of room to lever up. Preserving BHP’s “A” rating should not be a problem at all.

Strategic fit aside, Walter also fits the necessary financial profile. It sold 1.9 million tones of coking coal in the third quarter at average prices 70% higher than last year. The company generated free cash flow of $400 million on a trailing-12-month basis. That’s certainly worth more to BHP than storing its stash of cash at current low interest rates.

According to Capital IQ, Walter’s valuation — $5 billion enterprise value and 8.63 EV/Ebitda (trailing 12 months) — is also cheaper than some other U.S. coal miners such as Alpha Natural Resources, Arch Coal, CONSOL Energy Inc. and Massey Energy.

Given the longevity of Walter’s coal mines (18-20-year lives) and the versatility of its coal for both making steel and generating electricity for utilities, Walter would be a relatively low-maintenance acquisition for BHP.‹