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Walter Energy (NYSE:WLT) has a tendency to suddenly drop in price whenever there is negative regulatory news about coal in the U.S. The most recent example of this is the September 20th announcement of EPA regulations that limit new coal-fired power plants to emissions of 1,100 pounds of carbon dioxide per megawatt hour of power generated. This news sent most coal stocks tumbling since it puts new coal-fired power plants at a significant economic disadvantage due to the need for expensive carbon capture technology. Walter Energy fell 8% on this news, dropping from $15.02 to $13.77.

It is our opinion that these drops represent buying opportunities since Walter Energy is mainly a metallurgical coal producer that serves customers outside of North America. Walter Energy only produces a small and declining amount of thermal coal for use in power plants. Therefore, Walter Energy's stock price should not be affected by negative thermal coal news as significantly as it does.

Walter Energy Is A Metallurgical Coal Play

Walter Energy makes only a small proportion of its revenue from thermal coal. Most of its revenues come from metallurgical coal that is used for steelmaking. Thermal coal has been affected by regulations that impose additional costs on coal-fired plants. Along with low natural gas prices that encourage coal-to-gas switching among power plants that can use both, this is expected to put a cap on thermal coal's share of U.S. energy production.

On the other hand, metallurgical coal is not affected by these power plant regulations. Even if there are regulations surrounding carbon emissions from steelmakers, there should be limited impact on metallurgical coal. The ability to substitute natural gas for coal in steelmaking is much more limited than with power plants.

In 2011, Walter Energy generated 10.5% of its revenue from thermal coal. This declined to 9.5% in 2012 and 4.8% in the first half of 2013. This may fall further with the closure of the North River mine in March 2013. Thermal coal represents a relatively insignificant part of Walter Energy's portfolio, so regulations affecting thermal coal will have a very limited effect on Walter Energy's results.

Period

2011

2012

1H 2013

Thermal Coal Revenue ($ Million)

271

227

45

Total Revenue ($ Million)

2571

2400

933

Thermal Coal (% of Revenue)

10.5%

9.5%

4.8%

Walter Energy Is Internationally Focused

Walter Energy also receives the majority of its revenues from customers located outside North America. In 2012, 22% of Walter Energy's revenues were from North American customers, compared to 38% from Europe, 26% from Asia and 13% from South America. As a result, any U.S. regulations should not have a major effect on Walter Energy's results, with 78% of its revenue coming from outside North America. While steelmakers in Europe need to deal with carbon permits, the price of natural gas is significantly higher there, limiting its usefulness as a possible substitute for coal.

Revenues By Coal Destination
($ Million)

Destination

2012

Percent

Europe

923

38%

Asia

633

26%

North America

532

22%

South America

312

13%

Total

2400

100%

Effect of U.S. Regulatory News

As noted above, Walter Energy receives only 5% of its revenues from thermal coal, and only 22% of its revenues from North American customers. It should not be affected significantly by U.S. regulations, and certainly minimally affected by U.S. regulations that affect the use of thermal coal in power plants. However, Walter Energy's share price has dropped significantly on several occasions when there was U.S. regulatory news affecting (or perceiving to affect) thermal coal.

  • On November 7, 2012, Barack Obama's re-election sent Walter Energy's share price down 8.5% from $37.43 to $34.26. This was since Obama was expected to push for more regulations on carbon emissions from power plants in his second term.
  • On June 24, 2013, coal stocks declined on news that Obama would discuss climate change plan the next day that would include measures to reduce carbon emissions from power plants. Walter Energy declined 16.1% from $12.64 to $10.60.
  • On September 20, 2013, the announcement of EPA regulations setting low limits on carbon emissions from new power plants led Walter Energy to go from $15.02 to $13.77, a decrease of 8.3%.

Date

News

Prior Day Close

Closing Share Price

Change

November 7, 2012

Obama's Re-Election

$37.43

$34.26

-8.5%

June 24, 2013

Obama's Climate Change Plan

$12.64

$10.60

-16.1%

September 20, 2013

EPA Power Plant Regulations

$15.02

$13.77

-8.3%

Conclusion

It is our opinion that these type of events represent buying opportunities for Walter Energy. Since it receives very little revenue from thermal coal, and only a minority of its revenue from the United States, any U.S. regulations for thermal coal should only affect Walter Energy by 1% to 2% at most. Instead, prices have decreased by 8% to 16% in the past, and in the most recent case Walter Energy's share price still remains around 7% below its price before the power plant regulation news.

Other events that could significantly influence Walter Energy's stock price in the future is a bankruptcy filing from another coal company such as James River Coal. This may represent another buying opportunity if it happens. Walter Energy has faced some concerns over its liquidity, but in an earlier article, we mentioned that Walter Energy should be well positioned to ride out a weak market for metallurgical coal. As well, it recently announced a $450 million offering of senior secured notes that will improve its liquidity position. James River Coal faces much more serious concerns about liquidity and receives around 65% of its revenue from thermal coal and 67% of its revenue from U.S. customers. Given the differences in financial positions and revenue sources, any future problems at James River Coal should not be seen as a warning sign for Walter Energy.

Source: Walter Energy: Buying Opportunity After Regulatory News