We recently downgraded our long-term investment rating on Walter Energy Inc. (WLT) to Neutral, citing threats related to the moderation of the global steel markets, volatile commodity prices and cost escalations. Also, the company’s recent quarter results failed to impress, impacted by geological and weather-related issues, which has caused us to move to the sidelines.
Walter Energy’s second quarter operating earnings of $2.36 per share were substantially short of the Zacks Consensus Estimate of $4.09. The miss stemmed from a difficult geology in Alabama and weather-related challenges at both Alabama and Northeast British Columbia operations, raising the cost concerns for the company.
During the quarter, Walter Energy completed the acquisition of Western Coal, following which it revised its segmental reporting structure. The company now consists of three segments – The U.S. Operations segment, The Canadian and U.K. Operations segment and Other segment.
Despite poor second quarter results, Walter Energy expects metallurgical coal sales for the rest of 2011 to total roughly 5.9 million metric tons. Looking ahead, the company targets annual met coal sales volume growth of nearly 50% by the end of 2013.
Walter Energy also maintains a healthy balance sheet with a solid liquidity profile. It had a solid liquidity position of $424 million as of June 30, 2011, with cash balance of $134.2 million and the availability of $289.7 million under its credit facility.
On the positive side, however, Walter Energy continues to be an attractive investment due to its high-quality reserves, low mining costs and its proximity to a port. The company produces some of the best quality low-volatile metallurgical coal in the world.
Moreover, with the addition of the Western Coal assets, Walter Energy clearly stands to benefit from better production and reserves growth along with the anticipated strength in the global metallurgical coal markets. This should also help Walter Energy generate attractive cash flows going forward.
We believe Walter Energy’s current debt levels are manageable given its strong cash flow generating abilities, driven by expectations of increased hard coking coal production and favorable prices.
Further, we believe Walter Energy is very well positioned to capitalize on opportunities to grow and add significant value for its shareholders when the energy markets recover. However, as mentioned earlier, volatile commodity prices, shortfall in coal production or shipments, cost escalations and transportation issues, which may lead to reduced earnings for the company, keep us on the sidelines.
Tampa, Florida-based Walter Energy currently holds a Zacks #3 Rank (short-term Hold rating). The company competes head to head with CONSOL Energy Inc. (CNX) and Westmoreland Coal Co. (WLB).
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