Here's Why Walter Energy Isn't Impacted by the Proposed EPA Rules

The large drops by Walter Energy and Alpha Natural Resources following the proposed EPA rules on carbon emissions finally make the stocks look appealing.

Jun 4, 2014 at 10:58AM

The new proposed rules by the Environmental Protection Agency, or EPA, have far reaching impacts on coal used by power plants to produce electricity. It doesn't, however, impact coal used for steel and especially that exported to foreign locations. Based on this news, the large 10% decline by Walter Energy (NASDAQOTH:WLTGQ) is perplexing considering the coal miner is almost completely focused on the metallurgical export market.

With the recently released first-quarter results, the company has plenty of issues outside the EPA. From a China slowdown to an oversupplied metallurgical coal market, the company has plunged to new low after new low. Ironically, the ruling has a greater impact on Peabody Energy (NYSE:BTU) and the majority of stocks in the Market Vectors Coal ETF, which ended up virtually flat the day of the ruling. The reaction is very suggestive of a market overly negative on Walter Energy and fellow met coal leader Alpha Natural Resources (NYSE:ANR) despite the smaller EPA impact.

EPA decision
On June 2, the EPA came out with a proposal to reduce the carbon emissions from the power sector by 30% from the levels achieved in 2005. The mandate is for the reduction in carbon emissions to be met by 2030. The proposal, if approved, will greatly impact power producers focused on coal and the miners that provide that thermal coal.

Leading domestic coal miner Peabody Energy pointed out some issues with the EPA policy. According to the company, coal provided 90% of America's increased electricity needs during the polar vortex winter. In addition, it claims that more than a third of U.S. households qualify for energy assistance. Of course, Peabody Energy is tied to coal demand, but it has some good points on the source of low-cost electricity, calling into doubt whether some of the stricter parts of the proposal will be implemented.

These facts also call into question how the flexible proposals of the EPA will reduce electricity bills by 8% in 2030 if the low-cost source is removed from the equation.

Met coal focused
Of any domestic coal producer, Walter Energy is likely the least affected by the new EPA rules. According to the release by the company, it obtains 95% of revenues from the export of metallurgical coal.

The company projects full year 2014 met coal production to total 9.0 to 10.0 million tons after recently closing the high-cost mines in Canada. The company expects to sell 10.5 and 11.5 million metric tons based on production and nearly 2 million tons in inventory when the first quarter ended. In the last quarter, Walter only produced 174,000 metric tons of thermal coal. At roughly half the selling price of met coal, the thermal position is immaterial to the operations of the company.

Alpha Natural Resources faces more issues from Central Appalachia thermal coal production, which is a prime target of the EPA rules. Outside of that, Alpha Natural Resources is one of the largest met coal producers in the world with vast resources and access to export terminals. Even with the weakness in met coal prices, the company obtained roughly 36% of revenue from the higher valued coal source. It still leaves a substantial amount of revenue potentially affected by the EPA proposals.

Bottom line
When a government proposal impacts a stock more than warranted, it typically provides a buying opportunity. Walter Energy was hit mercilessly despite the limited impact the rules will have on the company. It's always possible that the 645-page EPA proposal contains hidden impacts only noticed by a few sellers, but more likely than not forced selling in the sector automatically dumped weaker stocks such as Walter Energy and Alpha Natural Resources, while buyers moved into the market to buy the stronger miners, such as Peabody Energy. Walter Energy is far from a safe investment, but at this point the market appears irrational on this name.

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Mark Holder and Stone Fox Capital clients own shares of Alpha Natural Resources. 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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