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Risk, Reward Balanced at Walter Energy

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On March 27, we have issued an updated research report on Walter Energy, Inc. . The U.S. coal producer and exporter is currently expanding its reserves and focusing more on cost-control initiatives. However, stringent environmental regulations and the possibility of an increase in competition from the Australian and Indonesian coal exporters can challenge the company’s future performance.

Walter Energy, a Zacks Rank #4 (Sell) stock, reported operating loss per share in fourth-quarter 2013, narrower than the Zacks Consensus Estimate and the prior-year figure. On the revenue front, top line lagged both the estimates as well as the year-ago result. Unfavorable performance was primarily due to lower metallurgical (met) coal prices, which negatively impacted higher coal sales volume.

In 2014, met coal demand is expected to increase primarily due to higher steel production. As per a World Steel Association report, steel demand will likely increase in 2014, primarily on the back of improvement in automotive, energy and construction sectors. We believe steel consumption will increase in China, India, Japan and the Middle East and North African region.

We remind investors that Walter Energy is well-positioned to meet higher future met coal demand. In fourth-quarter 2013, met coal production increased 28.3% year over year to 3.2 million metric tons. The company is currently focusing on its two deep underground mines – Mine No. 4 and Mine No. 7 – which have sufficient met coal reserve.

Walter Energy’s sufficient liquidity position, including $260.8 million in cash and $375 million available fund under the revolving credit facility, helped its steady reserve expansion program.

Apart from expanding asset base, Walter Energy is also following cost-curtailment program. The company’s cash cost of sales per ton for met coal, depreciation and selling, general and administrative expenses decreased year over year. These initiatives will enable Walter Energy to improve its future margins.

However, Walter Energy’s dependence on long-term customers is our cause of concern. The company generates major portion of its revenues from the long-term customers. If the company fails to retain current customers, renew the existing contracts, add new customers to its portfolio and sign new contracts, its future revenues will be affected.

Key Picks from the Sector

Other better-ranked stocks in this sector include Rhino Resource Partners LP , Westmoreland Coal Company and Oxford Resource Partners, L.P. . While Rhino Resource Partners carries a Zacks Rank #1 (Strong Buy), Westmoreland Coal Co. and Oxford Resource Partners hold a Zacks Rank #2 (Buy).

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