We recently reiterated our Neutral recommendation on the U.S. coal producer, Walter Energy Inc. (WLT).
Walter has two deep underground mines (mines 4 and 7) among others that produce some of the best quality metallurgical coal available in the world; several steam coal mines, a coke business and a natural gas business. It is one of the largest producers of premium metallurgical coal.
The company’s Blue Creek metallurgical coal is a premium product, which earns industry-leading margins. The company also benefits from the advantageous location of its metallurgical coal reserves.
Proximity of reserves to the Port of Mobile makes Walter a lowest cost provider of high-quality metallurgical coal in the U.S., providing relatively cheap and efficient access to its key product destinations and bolstering margins.
The Recent Quarter & Guidance
Walter Energy reported operating earnings per share of $2.16 in the second quarter of 2010, beating the year-ago earnings of $0.21 and the Zacks Consensus Estimate of $1.94. The results benefited from improved sales volumes, which resulted in the outperformance of all business segments.
For the third quarter of 2010, Walter guides coking coal production volumes of about 1.8 million tons priced at nearly $60 per ton. The company also expects coking coal sales volumes to stay in the range of 1.8 to 2.0 million tons for the quarter.
Despite positive results in the second quarter and strong volume guidance for the third quarter, Walter’s management recently lowered its fiscal 2010 coking coal sales guidance to 7.2 – 7.5 million tons (7.7 – 7.9 million tons previously) driven by lower production forecasts for 2010. The company expects the difficult mining conditions at Mine No. 4 to affect its overall production target for the year.
Industry Scenario
Recent news flow suggests a slight slowdown in world steel production, leveraging on Chinese steel output. Thus, met coal being the main ingredient for steel production, its demand has been affected across the world.
According to the World Steel Association, China’s steel production in August 2010 slipped, while other Asian and European markets continued to rise. Crude steel capacity utilization ratio in the U.S. and around the world declined to a year low of 73.1% in August 2010 from 74.4% in July 2010.
Although met coal prices have been steady so far, we believe the tempered steel production and utilization trends may prevent metallurgical coal prices to rise from current levels. Looking ahead, we believe any signs of further slowdown in China or the global steel markets may significantly impact the metallurgical coal producers.
Our Take
Though we believe Walter is an attractive investment due to its high-quality reserves, low mining costs and the advantage of its proximity to the port, we remain on the sidelines due to the company recently lowering its production guidance and poor expectations of met coal prices in the near term. Our cautious view on the stock also stems from the ongoing risks associated with the moderation of met coal markets.
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