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1 November 23, 2012 Walter Energy (WLT-NYSE) Current Recommendation Prior Recommendation Neutral Date of Last Change 09/05/2012 Current Price (11/21/12) $28.83 Target Price $26.00 UNDERPERFORM SUMMARY Walter Energy Inc. posted lackluster results in the third quarter with both top and bottom lines lagging the Zacks Consensus Estimates. The global coal market downturn and softness in selling prices negatively impacted results. The global economic stalemate is expected to linger on, thereby dragging down the company s sales and profit. Declining sales resulting in coal stockpiles would prove unprofitable for the company in the short term. This along with the company s narrow capex outlook for 2013 is expected to shake investors confidence. However, cost containment efforts in the Canadian mines and efforts to improve financial flexibility could somewhat temper the strong negatives. SUMMARY DATA 52-Week High $ Week Low $28.78 One-Year Return (%) N/A Beta 1.76 Average Daily Volume (sh) 3,337,781 Shares Outstanding (mil) 63 Market Capitalization ($mil) $1,816 Short Interest Ratio (days) 2.07 Institutional Ownership (%) 72 Insider Ownership (%) 1 Annual Cash Dividend $0.50 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 19.3 Earnings Per Share (%) 22.2 Dividend (%) 18.9 using TTM EPS 9.5 using 2012 Estimate 30.3 using 2013 Estimate 20.4 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page Risk Level * Above Avg., Type of Stock Mid-Value Industry Coal Zacks Industry Rank * 226 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 411 A 464 A 401 A 1,588 A A 773 A 690 A 700 A 2,571 A A 678 A 612 A 617 E 2,539 E E 647 E 688 E 2,726 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2010 $0.77 A $2.16 A $2.55 A $1.72 A $7.18 A 2011 $1.53 A $1.71 A $1.21 A $1.34 A $5.76 A 2012 $0.78 A $0.43 A $0.48 A -$0.74 E $0.95 E $0.05 E $0.29 E $0.65 E $1.41 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved North Canal Street, Chicago IL 60606

2 OVERVIEW Tampa, Florida-based Walter Energy Inc. is one of the leading U.S. producers and exporters of premium metallurgical coal to the global steel industry in the United States. The company also has a steam/industrial coal mining business, although much smaller in size than its metallurgical operations. It also produces metallurgical coke and coal bed methane gas. It owns a Birmingham, Alabama based manufacturing unit of coke and coke byproducts. Its de-gassing division, also headquartered in Alabama, extracts coal bed methane gas (natural gas) through an equally-owned joint venture with the exploration and production subsidiary of El Paso Corp. (EP). In 2011, the company s revenue was roughly $3.0 billion and it employed nearly 4,200 in the United States, Canada and United Kingdom. Walter produces metallurgical coal through its subsidiary Jim Walter Resources (JWR) consisting of Jim Walter Resources mines No.4 and No.7; steam coal and industrial coal through its Walter Minerals subsidiary Tuscaloosa Resources (TRI) and Taft Coal & Sales (Taft);and metallurgical coke through its Walter Coke subsidiary (formerly Sloss). It is also a significant producer of natural gas. In 2011, metallurgical coal production totaled 5.9 million metric tons while thermal coal volume was 3.4 million metric tons. On the other hand, natural gas production reached approximately 19.5 billion cubic feet during Walter possesses million metric tons of recoverable reserves in its core operations at Alabama The company, formerly known as Walter Industries Inc., changed its name to Walter Energy Inc. in April 2009, reflecting the closure and spin-off of its homebuilding and financing businesses. The company is now a pure play natural resources and energy company. Following the successful completion of the Western Coal acquisition, Walter has revised its segmental reporting structure. Beginning with the second quarter of 2011, the company reports in three operating segments the U.S. Operations segment, the Canadian and U.K. Operations segment and the Other segment. Both the U.S. Operations and Canadian and U.K. Operations reportable segments primary business is that of mining and export of hard coking coal for the steel industry. The U.S. Operations segment comprises Walter's historical Underground Mining, Surface Mining and Walter Coke operating segments, along with the recently-acquired West Virginia mining operations (part of the Western Coal acquisition) and the North River Mine acquired in May The Canadian and U.K. Operations segment include 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 consists of Corporate activities and expenditures. Equity Research WLT Page 2

3 Source: Company REASONS TO SELL Walter Energy s metallurgical coal exports are expected to face the brunt of the global downturn in steel markets. The continued softness in the markets of Asia and Europe and dull prices will drag down export revenue significantly. Walter Energy is also contemplating to idle its Aberpergwm project in Wales which could impact the top-line going forward. The company s production glut during the quarter led to an increase in coal stockpiles of $58 million which is expected to prove unprofitable in the short term owing to tepid demand. In view of the weak U.S. macro environment, Walter Energy has tightened its capital outlay for 2013 to $220 million down from the 2012 s projected capital expenditure of $400 million could shake investor s confidence on the company s stock. The ability to acquire and develop reserves is a critical part of Walter s operational success. If it is unable to acquire reserves at favorable prices or mine the reserves due to geological or economic conditions, its profitability can suffer. The company reevaluated its expenditure on a shale gas project which proved to be ineffective in terms of providing additional reserves. This cost the company a pre-tax charge of $40 million and an after-tax charge of $25 million which will impact Walter Energy s financials. Walter s operations are concentrated in areas of Alabama and Northeast British Columbia, so any interruption in production process or delays owing to governmental regulation, transportation capacity constraints and extreme weather variations could expose the company to severe operational losses. The company s business requires efficient, cost effective raw materials and mining equipment. Walter s operations rely upon the availability of steel and petroleum products. Rise in prices of steel scrap, petroleum and equipment could lead to operational austerities. In the wake of increasing support for pro-environment regulations by the government, coal mining and producing companies like Walter Energy, who contribute to Greenhouse Gas Emissions (GHG) directly, could witness an increase in operational costs. The implementation of GHG structures such as a "cap and trade" program and emissions trading will lead to substantial reductions in emissions. Hence, production and demand for the company s coal products will likely fall as more companies switch to alternative fuel sources. This would ultimately lead to a drop in top-line results and hurt margins. Equity Research WLT Page 3

4 RISKS Walter Energy s operations focus mainly on its two deep underground mines (mines 4 and 7), which produce some of the best quality metallurgical coal for the global steel industry. With its advantageously located, high quality metallurgical reserves, the company is positioned as one of the largest producers of premium metallurgical coal in the world. The company s Canadian operations were successful in its cost containment efforts. Both its Brule and Wolverine mines recorded significant decline in cash cost and also surpassed their cost-minimization targets for We believe with the current soft demand conditions in the U.S. and globally, the company s continued cost control initiatives could to an extent ease margin pressure. Walter Energy is committed to maintaining a healthy balance sheet with a flexible liquidity portfolio. Its cash balance was $129.9 million as of September 30, 2012, marginally up from the year-end 2011 level. We believe Walter s current debt levels are manageable given its strong operating cash flows, which during the quarter was $333.0 million. This will also enable the company to smoothly execute its growth related projects. RECENT NEWS Walter Offers $500M Senior Notes November 19, 2012 Pure metallurgical coal play, Walter Energy Inc. announced that it will offer 9.875% senior notes worth $500 million due 2020, to recompense outstanding amounts under its credit facilities, for fees and expenses and for general corporate purposes. The interest is payable on the 15th of June and December, respectively, for each year with the first one being rewarded on June 15, The offering of notes is expected to be completely guaranteed by Walter Energy and its key business wings. At the end of third quarter 2012, Walter Energy s debt-to-equity ratio stood at 199.8%, up significantly from 106.2% at year-end Moreover, with the issuance of notes, Walter Energy s debt-to-equity ratio will further increase to 243.7%. The company has sparingly resorted to issuance of notes. However, its high-cost asset purchases, especially of the Canadian mines, have led to debt escalation. The $3.3 billion acquisition of Western Coal Corporation and the current proposed offering would continue to keep the company under debt pressure. The company s long-term debt level as of September 30, 2012, was $2.3 billion, unchanged from the yearend 2011 number. Interest expenses of the company in the third quarter 2012 were $30.5 million which could increase in the upcoming quarters with the currently proposed issuance. Standard & Poor and Moody s provided B+ and B3 ratings, respectively, implying uncertainty as to the company s capability in meeting its financial commitments. Meanwhile the current softness in the global steel market will likely result in tepid demand for met coal. Walter Energy Lags on Lower Volume November 5, 2012 Metallurgical coal producer Walter Energy Inc. s operating earnings per share in the third quarter of 2012 were $0.48 per share versus $1.21 reported in the year-ago quarter. Earnings were lower than the Zacks Consensus Estimate of $0.55 per share. Equity Research WLT Page 4

5 GAAP loss during the quarter was $16.97 per share versus earnings of $1.39 per share reported in the yearago quarter. The difference between operating and GAAP earnings during the quarter under review was due to a noncash goodwill impairment charge of $1.1 billion and a charge of $40 million for abandonment of a natural gas exploration project. The results during the quarter included a $41 million tax benefit. Revenue Walter Energy s total revenue of $611.9 million in the third quarter was lower than $688.7 million reported in the year-ago period. The year-over-year decline was due to global slackness in the demand for coal accompanied by an excess of supply. The contribution from the Canadian and U.K. operations of the company dropped 41.1% year over year. The top-line results were also lower than the Zacks Consensus Estimate of $669 million. Sales and Production During the quarter, Walter Energy s metallurgical coal production reached 3.33 million metric tons (MMTs), up 47% from the year-ago quarter. The production consisted of 71% met coal and 29% pulverized coal injection (PCI) coal. Sales volume during the reported quarter touched 2.62 MMTs comprising 2.18 MMT of HCC and the balance PCI. Operational Update During the quarter the company successfully implemented cost-cutting measures. Selling, general and administrative expenses were $32.5 million, down 24.6% from $43.1 million in the year-earlier quarter. Third quarter operating profit at Walter Energy totaled $34.9 million, down sharply 77.9% from the same period last year, due to operating losses incurred at its Canadian and U.K. operations. Interest expenses were $30.5 million versus $27.6 million in the prior-year quarter. Financial Update The company continues to maintain a healthy cash balance. Cash and cash equivalents as of September 30, 2012 were $129.9 million versus $128.4 million as of December 31, Long-term debt as of September 30, 2012 was $2.28 billion versus $2.27 billion as of December 31, In the third quarter, capital expenditure was $85.2 million compared with $156.9 million in the year-ago quarter. The decline in capital expenditure reflects Walter Energy s capital discipline in the face of a worldwide decline in coal demand. The capital expenditure target of the company for 2012 is $400 million. Keeping in mind the sputtering global economy, the company has decided to lower its capital expenditure for 2013 to $220 million. Cash from operating activities during the first nine months of 2012 was $333 million versus $509.6 million in the year-ago period. Equity Research WLT Page 5

6 VALUATION We believe the company would face operational hurdles due to the continued weakness in U.S fundamentals. The company s moderate capital outlay in 2013 is also expected to weaken shareholders confidence. Besides, commodity price sensitivities and pressure from regulatory bodies will thwart the company s growth opportunities. However, effective cost management in the Canadian units and the company s effort to maintain a stable balance sheet could provide some hope for the company. Walter s shares are currently trading at 12-month trailing earnings multiple of 9.5X, compared to the 10.6X average for the peer group and 14.2X for the S&P 500. The stock is trading at a premium compared to its peers and to S&P 500. The trailing 12-month EV/EBITDA multiple is lower than the industry average. We remain bearish for the company stock in the long run. Our $26.00 target price is based on 2.4x trailing 12- month cash flow per share. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low WALTER ENERGY (WLT) Industry Average S&P Arch Coal Inc. (ACI) N/A N/A N/A 5.7 CONSOL Energy Inc.(CNX) Patriot Coal Corporation (PCXCQ) N/A N/A N/A 0.1 N/A Alliance Resource Partners P. L. (ARLP) N/A TTM is trailing 12 months; F1 is 2012 and F2 is 2013, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA WALTER ENERGY (WLT) Industry Average N/A S&P N/A 2.2 N/A Equity Research WLT Page 6

7 Earnings Surprise and Estimate Revision History Equity Research WLT Page 7

8 StockResearchWiki.com The Online Stock Research Community Discover what other investors are saying about Walter Energy (WLT) at StockResearchWiki.com: DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of WLT. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1012 companies covered: Outperform %, Neutral %, Underperform 7.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research WLT Page 8