Will Walter Energy’s Sales Dwindle in the Second Quarter?

Let’s review the main factors that could affect the company’s bottom line in the second quarter.

Jun 13, 2014 at 2:19PM

The metallurgical coal market hasn't done well in the past year as prices have dwindled. This weakness has led Walter Energy (NASDAQOTH:WLTGQ) to report high losses in the first quarter. Will the company's performance improve in the second quarter? Or will its revenue and earnings continue to tumble? Let's examine some key factors that will impact the company's performance in the near future.

Will the met coal market improve?
During 2013, total met coal exports dropped by 6% compared to 2012, according to the Energy Information Administration. Most of this fall in exports is due to the 16% drop in exports to Asia (mainly India and Japan). The 15% rise in Australia's met coal exports has softened the demand for met coal from the U.S. Moreover, the EIA's report showed the average price of U.S. metallurgical coal exports plummeted by 24% to $115 per ton. Looking forward, the rise in Australia's exports and the limited growth in the steel market are likely to slowly drag down metallurgical coal prices. Further, in 2014, the EIA expects U.S. met coal exports to fall by nearly 13%, year over year.

For Walter Energy, during the first quarter the average realized price of met coal dropped by 16.8%, year over year. Even if the average price remains stable in the second quarter, the prevailing prices are roughly 15% below the average price recorded in the second quarter last year. Therefore, the current low prices of met coal will keep dragging down Walter Energy's revenue. The other side of the equation is production.

In the first quarter, the company met coal sales (in tons) fell by 6%, year over year. Further, this year the company estimates to sell around 9.5 million tons of met coal and a total of 11 million tons of coal (including thermal). Based on the above, Walter Energy expects to sell around 2.7 million tons during the second quarter -- nearly the same amount it sold in the same quarter last year.

Thus, the company's revenue is likely to dwindle by 15%, mostly due to lower coal prices (assuming the prices won't fall further). Production volume won't negatively impact its sales. Despite the lower revenue, the company's earnings and operating cash flow could pick up. Let's see why. 

Profit margin
Despite the low coal prices, Walter Energy's gross profitability slightly improved in the past quarter, mainly due to a 23% fall in its coal cash cost of production. The company expects to keep cutting its production costs, which will offset the low coal prices. Moreover, the margins the company makes on met coal remain higher than that of Arch Coal (NYSE:ACI) and Alpha Natural Resources (NYSE:ANR). These companies' operations mostly rely on thermal coal rather than met coal. The chart below demonstrates the changes in their gross profitability.

Walter Profit Margin

Source: Google Finance

If Walter Energy keeps reducing its cash cost, this could reduce its net losses in future quarters.

Final note
Despite low met coal prices, Walter Energy might improve its gross profitability and record low losses in the second quarter. The production is likely to remain nearly stable during the quarter and the drop in production could offset the drop in coal prices. Nonetheless, the company still faces high debt, and unless the met coal market starts to heat up, Walter Energy will keep recording losses and accumulate debt.

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Lior Cohen 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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