More Than Meets the Eye in Last Week's Earnings Warning
Last week Walter Energy (WLT) warned on 2q earnings due to lower realized coking coal prices. However, they also reported that production has been running well all year and that sales volumes remain on track. This is important because Walter has a long history of production shortfalls due to difficult mining conditions. As a prospective investor in the stock or viewing WLT as a takeout target, steady production and sales volume outweighs an earnings miss. One can comfortably conclude that the earnings miss is largely due to market forces.
Thinking this through, last week's announcement actually highlights the strength of the company. Most U.S. coal producers have voluntarily cut production due to slack demand. Many are being forced to shut-in production due to customers being unable or unwilling to take contracted coal. As a result, Walter's peers are suffering death by a thousand cuts. They don't have the premium hard coking coal that Walter has, so their realized coking coal prices are down more than Walter's. Their costs per ton are increasing due to lower volumes, while Walter's costs per ton are flat.
Competition for port space is fierce, but Walter has all it needs in the Gulf and the option to either rail or barge its coal a relatively short distance (freight costs are about half that of peers). While others struggle to increase exports, Walter already exports the vast majority of its coking coal. Consol Energy, (CNX), Patriot Coal, (PCX), Alpha Natural Resources, (ANR), James River, (JRCC), Arch, (ACI) and Alliance Resource Partners (ARLP) are trying to ramp up volumes of coking coal as fast as they can.
No U.S. Player Can Touch Walter's Premium Hard Coking Coal Franchise
Walter's goal is to increase from a run-rate of about 12 million tons today to 20 million tons by the end of the decade, a gain of 75%. With the possible exception of ANR, none of Walter's peers has organic growth opportunities of 8 million tons. Arch, Patriot and Consol will probably each be able to get 4-6 million incremental tons online, but very little of that tonnage will be premium hard coking coal.
So while analysts are busy chopping 2012 estimates for Walter, I suggest that investors consider the silver lining in last week's earnings warning. When coal fundamentals improve more sustainably, perhaps evidenced by a quarterly premium hard coking coal benchmark price of $250 per metric tonne, Walter will be sitting pretty. And when that time comes, guess which coal producer will be the subject of takeout speculation?