Walter Energy: Bullish on Met Coal But It Might Not Matter

Bullish talk about met coal doesn't help Walter Energy or the sector until it can show a path to strong profits.

Feb 22, 2014 at 2:23PM

After weak met coal guidance from Alpha Natural Resources (NYSE:ANR) and Arch Coal (NYSE:ACI), Walter Energy (NASDAQOTH:WLTGQ) surprised the market with bullish commentary on the coal needed for steel production.

Walter Energy is the largest pure-play met coal miner trading on the domestic stock exchanges. After closing another thermal coal mine, the company expects to only produce 300,000 tons of thermal coal this year, leaving the sole thrust on met coal. Other domestic coal miners produce met coal along with sizable amounts of thermal coal used for electricity production.

Walter Energy continues to generate large losses due to huge interest expenses for a firm its size leaving a major question mark of whether a rebound in met coal demand and prices will even be enough to produce solid profits.

Met coal forecast
The CEO of Walter Energy forecast the met coal market will use 30 million more tons in 2014. The company suggested that global steel demand would increase by 3.3% this year due to a rebound in Europe. China remains the large wildcard to the equation.

The main factor in the weak met coal prices during 2013 was increasing supply from Australia, which won't be repeated in 2014. In fact, with met coal in a short-term oversupply situation, the expectation is that more mines will be curtailed this year, along with very limited capital expenditures. Walter Energy expects to spend less than $150 million on projects this year after spending $391 million back in 2012.

While Alpha Natural mostly painted a similar picture when it reported a week ago, the company still sold less met coal during the fourth quarter than in prior periods. Alpha forecasts shipping 16 to 20 million tons of met coal during the year, compared to shipping over 20 million in tons in both 2012 and 2013. On the low side of forecasts, Alpha would ship 20% less met coal this year.

Arch Coal only expects to produce between 7.5 to 8.5 million tons of met coal during 2014. Also, the company expects to follow the trend of lower capital spending by reducing the yearly amount to only $200 million in 2014. This follows a $100 million reduction in 2013 after spending nearly $400 million in 2012.

Lower costs not enough  
Maybe the most discouraging factor in the Walter Energy saga is the continued losses even after drastic cost cuts. For the fourth quarter alone, the heavily indebted miner had $65 million in interest expense on revenue of only $471 million. In essence, the adjusted net loss of roughly $35 million was entirely made up of costs to service the debt that now sits at $2.8 billion.

Walter Energy achieved significant cost reductions during 2013 that culminated in substantial year-over-year improvements in the fourth quarter. The cash costs to produce a ton of met coal declined by 21% while sales and administrative expenses dropped 30%. Unfortunately, the addition of 14% more tons sold still didn't produce positive income due to declining prices for met coal.

In both cases, Arch and Alpha Natural reduced the costs of coal production along the lines of Walter Energy, but neither coal miner has figured a way to make the companies profitable. After absorbing fourth-quarter results and 2014 guidance, analysts still forecast substantial losses for at least the next couple of years.

Bottom line
While Walter Energy proclaimed a more cheery met coal market for 2014 than generally suggested by other coal firms, the large losses in the domestic producers still leaves companies bleeding cash into the future. The improving steel demand in Europe should provide help for domestic producers when shipments from the East Coast find that destination more appealing than Asia. In addition, the continued slump in capital spending will dramatically impact the ability of the industry to keep up with rebounding demand. Investors need only to watch the dramatic surge in natural gas prices to realize what happens when a market doesn't stay in balance.

Walter Energy, Arch Coal, and Alpha Natural are difficult to invest in until the sector shows a hint of returning profitability.

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Mark Holder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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