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Introduction

Walter Industries (WLT) is a $4.63 billion company in the coal industry. Market capitalization competitors in this industry include Masssey Energy, Arch Coal, and Alpha Natural Resources. The coal industry is up 74.90% over the past year compared to the S&P 500 which is down 6.12% during the same period. Over the past month, the industry has been up 20.14%, while the S&P 500 has been up 5.61%. Strong technical trends may be indicative of a continued expansion in this industry. Evidence comes from a potential turnaround in general equities. Moreover, as there seems to be evidence of confidence in equities, commodity stocks like Walter will see future benefits. Also Walter’s growth and valuation illustrate the potential for a strong earnings report next quarter.

Business

This section describes what Walter’s produces. According to Reuters, Walter, “offers a line of products and services, including coal and natural gas, furnace and foundry coke and slag fiber, mortgage financing, and home construction.” There are many segments that diversifies Walter’s overall business model to become more risk-adverse. These business segments include natural resources, sloss, financing, and homebuilding. The diversified product line is different from other companies and puts Walter ahead in many areas.

First, relating to natural resources, Walter focuses on mining, specifically in locations around Alabama. After the original mining, the resources are later sold to a myriad of customers including those in Turkey, South America, and Europe. The international element is excellent for Walter. As the dollar still remains in a very fragile situation, the propensity for exports increase, and companies like Walter will benefit. Moreover, Walter also operates under other business segments. Sloss, is used to help produce foundry coke, furnace coke, and slag fiber. These products are used for many agricultural and manufacturing overhead. Walter also offers an insured financing business and a homebuilding segment, focused on the southeast portion of the United States.

Growth

Walter’s has illustrated solid growth prospects over the past year. According to Reuters, Walter’s reported a $1.24 billion revenue product last year. This number is down over 5.00% than it was the previous year. Compared to the industry’s average of 2.71%, investors see the relative weakness compared to other competitors. This number is also lower than the company’s five year average of (1.50)% and competitor annual averages of 8.08 % ( Massey) and 4.28% (Arch Coal). While these numbers may look discouraging, Walter still has performed extremely well over the past year, and with better numbers, this company has the potential to move even higher. Walter’s earnings fell at an astonishing 44.59% last year—a number much lower than the industry -23.29% average. Competitors such as Arch Coal only saw a -0.60% improvement and Alpha Natural Resources saw a disappointing decrease in earnings of -59.65%. Therefore, earnings are relatively similar related to Walter’s growth history.

In addition, Walter’s has kept its costs under control. According to Reuters, Walter’s has reported gross, operating, and net profit margins of 28.35%, 9.24%, and 6.79% respectively over the past year. Moreover, these numbers are above the industry averages of 24.48%, 11.55%, and 8.06%, respectively. The numbers are also above the company’s five year average respective numbers of 26.60%, 8.32%, and 6.05%. This comparison illustrates a history of strong cost controls and positively-related consistency. The current averages are also better (business model respected) than competitor Massey Energy’s respective operating and net income averages of 7.88%, and 4.22%. The same comparison can be made for Alpha Natural Resources and Arch Coal Therefore, Walter’s has proved to be a solid company in this industry. Its services are well-controlled cost wise, especially to direct market-cap competitors.

Compiling all this information together and investors comes across ROE. Over the past year, Walter’s reported an ROE of 111.98%. Therefore, out of all shareholder equity, more than 112% (above five year average) come from earnings instead of debt or stock. This number is much stronger compared to the industry average of 13.58%, and the number is better than some competitor averages 13.13% (Massey) and 15.14% (Arch Coal). Therefore, Walter’s has a history of strong earnings per its equity share—which reflects the strong capital gain movement over the past year. And if history is any indication, there should be no reason why Walter’s cannot continue its success. The same logic applies to Walter’s 6.19% ROA (above industry average) and 7.56% ROI (above industry average).

Valuation

With fairly high growth estimates and historical data, there should be evidence of an overvalued company. However, this is not strictly the case. Walter’s has a forward P/E ratio of 15.28 and a price to sales ratio of 2.90 compared to the industry’s respective 53.23 and 3.64, which shows a relatively undervalued status. In comparison, the rest of the market cap competitors have ratios that higher than Walter’s. Massey Energy has a forward price to earnings ratio of 19.44, and Alpha Natural has a 29.83 forward price to earnings ratio. What makes Walter’s figures are more enticing is these competing firms aren’t growing so greatly as strongly as Walter’s. Walter’s can now be seen as both a growing and valued company. Moreover, Walter’s has a relatively low PEG (0.45) ratio compared to other competitors’ numbers as well.

Efficiency

Walter’s is efficient. Inventory turnover at 6.12 is strong compared to other industry market-cap rivals. Moreover, asset turnover is also strong at 0.44 compared to competitor figures. Receivables turnover also illustrates a number of 0.52 illustrating cash received every 700 days. In terms of liquidation, Walter’s current ratio is a bit high. This number is a bit risky, but the company’s capital expenditures have increased (21.30%) which means further increases in capacity and economies of scale may be present in the future, because of this financing. Moreover, institutions own 95.00% of all Walter’s shares. Since the institutional investors have a larger gross amount of capital to lose compared to the retail investor, a high institutional percentage illustrates confidence in the stock's ability. Walter also has a solid dividend ratio at 0.23%.

Technical Analysis

Walter’s performed flat in the past year. The company’s share price has increased 220% year-to-year. This type of growth is amazing for a recessionary-type economy, especially considering the fact that the housing market and construction is doing so poorly. There seems to be some support at the 70 dollar share price range dating back to earlier May 2008. The last time Walter’s reached this amount the company rebounded and appreciated 23%. There is a possibility a similar or better situation could occur in the future.

More specific to the current month, Walter’s illustrates strong technical signals. Parabolic SAR is below and upward trending the current share price. This event usually signals an upturn in share price. The company is a little undervalued compared to the RSI index at 43.32, but it is better to be an advocate of fundamental valuations before technical valuations. Therefore, while now isn't the most ideal time to purchase shares of Walter’s according to technical analysis, purchasing shares will still produce strong long terms gains.

Conclusion

Walter Industries is a great acquisition for any portfolio. The company's business model and fundamental analysis are both strong. It is very rare to find a company that has both strong valuation and growth, so it is wise to take advantage of these situations as they arise.

-Dennis Biray
May 16th, 2008