(WLT) Walter Energy Misses on Weather Woes

Second quarter operating earnings for Walter Energy Inc. (WLT) came in at $2.36 per share, falling substantially short of the Zacks Consensus Estimate of $4.09. Such a miss stemmed from difficult geology in Alabama and weather-related challenges at both Alabama and Northeast British Columbia operations, raising the cost concerns for the company.

On a GAAP basis, the leading met coal producer and supplier recorded an EPS of $1.71 compared to $2.16 earned in second quarter of 2010.

Revenue and Operating Income

Walter Energy’s total revenue of $773.0 million in the second quarter was below the Zacks Consensus Estimate of $963 million. Revenues, however, increased 88.3% from the year-ago comparable period, mainly due to the addition of operations in Canada, West Virginia, U.K. and North River,and higher metallurgical coal pricing in the U.S. operations.

During the quarter, Walter Energy’s metallurgical coal sales reached a record 2.7 million metric tons, an increase of 80% compared to last year. Total metallurgical coal production volumes improved 58.7% year over year to 2.5 million metric tons in the second quarter 2011.

This increase in sales and production came primarily from the volumes produced and sold in Canada, West Virginia and Wales operations.

Second quarter operating profits at Walter Energy totaled $153.6 million, registering a dip of 9.8% from last year, impacted mainly by higher per ton production costs. EBITDA for the quarter was $267.6 million, up 37.9% from the second quarter 2010.

Segmental Shuffling

Following the successful completion of the Western Coal acquisition Walter Energy has revised its segmental reporting structure. The company presently consists of three segments – The U.S. Operations segment, The Canadian and U.K. Operations segment and Other segment.

The U.S. Operations segment comprises Walter Energy’s historical Underground Mining, Surface Mining and Walter Coke operating segments along with the recently acquired West Virginia mining operations (acquired as part of the Western Coal acquisition) and the North River Mine acquired in May 2011.

The Canadian and U.K. Operations segment includes mining operations in northeast British Columbia (Canada) and in South Wales (United Kingdom), both of which came into its ambit through the Western acquisition. The Other segment primarily includes corporate expenses.

Segmental Synopsis

U.S. Operations: The segment’s second-quarter revenues increased 23.6% over last year reaching $506.9 million, while operating income declined $13.4 million to $168.7 million. The rise in revenue was driven by the inclusion of the West Virginia and North River mining operations and higher met coal prices, offset by lower sales volumes in Alabama. However, operating income for the quarter declined due to higher cost per ton related to lower production volumes in Alabama and increased freight expenses.

The U.S. Operations sold nearly 1.5 million metric tons of metallurgical coal in the second quarter 2011, almost in line with the year-ago quarter’ssales. Despite unimpressive volumes sold, the company’s second quarter revenues benefitedfrom better metallurgical coal pricing at the U.S. operations. Met coal prices in the U.S. averaged $236.37 per metric ton, up from $213.13 per metric ton in the prior-year period.

Total volumes produced at the U.S. Operations improved 4.7% year over year to 1.6 million metric tons of metallurgical coal with U.S. production costs escalating by 13.2% to $75.16 per metric ton.

Canadian and U.K. Operations: This segment reported operating income of $12.4 million for the second quarter 2011 on revenues of $265.6 million.

Total metallurgical coal sales at the segment were 1.1 million metric tons in the second quarter 2011 at an average sales price of $231.54 per metric ton. The segment produced 0.9 million metric tons of metallurgical coal in the quarter at an average cost of $137.35 per metric ton. Challenging weather conditions and permit delays in Northeast British Columbia impacted sales and production volumes, as well as production costs, in the quarter.

Other segment: The Other segment reported $15.6 million in operating losses, higher than the year-ago period, primarily due to Western and North River acquisition costs.

Financial Update

As of June 30, 2011, Walter Energy had a liquidity of about $424 million, including $134.2 million in cash, cash equivalents and marketable securities and about $289.7 million under its credit facility. Total long-term debt was roughly $2,386.8 million.

In the second quarter, the company reported nearly $92.1 million under capital expenditure, an increase of $61.4 million from last year. The increase in spending mainly stemmed from the expansion of the Canadian operations, with about $51.7 million spent for Canadian and U.K. operations and nearly $13.9 million spent towards U.S. operations.

Guidance

Walter Energy expects metallurgical coal sales for the rest of 2011 to total roughly 5.9 million metric tons. Looking ahead, the company targets annual met coal sales volume growth of nearly 50% by the end of 2013.

Our View

With the acquisition of Western Coal now complete, Walter Energy clearly stands to benefit from better production and reserves growth along with the anticipated strength in the global metallurgical coal markets.

Walter Energy’s rival CONSOL Energy Inc. (CNX) excelled in the second quarter on the back of record revenue growth at the company’s Coal Division, which has now recorded a rise for the fifth quarter in a row. Adjusted earnings of 96 cents per share for the second quarter of 2011 matched the Zacks Consensus EPS forecast.

Walter Energy currently holds a Zacks #3 Rank (short-term Hold rating), which supports our long term ‘Neutral’ recommendation on the stock.

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