Costs down and prices set to rise for Western Coal

Vancouver – An effort to reduce cash costs during the recession is paying off for Western Coal (WTN-T), as lower costs allowed the company to earn $24 million during the last three months of 2009 ahead of annual coal contract negotiations that will likely increase the price the company’s coal fetches.

Third quarter earnings comprised the bulk of Western Coal’s earnings for the nine-month period that ended on New Year’s Eve. From April to December the company brought in $302 million from coal sales but retained only $29.6 million in earnings. Of that, in the third quarter alone, from October to November, Western Coal sold $118.7 million worth of coal and retained $24 million in earnings.

Western Coal’s Canadian operations are all in northeast British Columbia. The Wolverine mine produces hard coking coal, a key blend component for global steel mills. The Brule mine produces ultra-low volatile pulverized coal injection coal (ULV-PCI), primarily for export to Korea, and the Willow Creek mine produces metallurgical coal. In West Virginia, the Gauley Eagle and Maple mines churn out both thermal and metallurgical coal.

For fiscal 2010, which started in April 2009 and wraps up at the end of March, Western Coal’s contract prices for its Canadian coal are US$126 per tonne for hard coking coal and US$90 per tonne for ULV-PCI coal. The company’s American coal is currently priced between US$78 and US$83 per ton

Earnings improved in the third quarter primarily because Western Coal continued to lower its operational cash costs. In Canada, cash costs including transportation came in at $96 per tonne or 4% lower than the previous three months. In the United States, it cost Western Coal US$66 to produce a ton of coal, which represents a 7% reduction in cost compared to the previous quarter.

The company’s Canadian cash costs should improve again before the middle of 2010, as Western Coal recently approved the $23.9-million purchase of six new 250-tonne haul trucks and front-end loaders for Wolverine. The new equipment will replace eight 150-tonne trucks, which could be redeployed to Brule and Willow Creek, and the move should increase productivity and costs at all three mines.

More generally, fiscal 2011, which for Western Coal starts at the beginning of April 2010, should prove a much stronger year for the company as renewed strength in the global steel sector continues to buoy demand for metallurgical coal products. Coal contracts are usually negotiated in March or April, so the fact that capacity utilization in the steel industry is approaching the levels seen prior to the slump bodes well for Western Coal’s contract negotiations.

On a darker note, in late 2009 Western Coal was hit with a class-action lawsuit from investors alleging that management artificially deflated the company’s share price in order to buy shares. In early November 2007 Western Coal shares were trading between $1.40 and $2.40. On Nov. 14 the company released its financial results for the second quarter and announced that it did not expect to have sufficient funds in the near term to meet its financial obligations, citing coal prices and the Canadian-American exchange rate. On the news Western Coal’s share price plunged from $1.75 to 47¢ in a day.

Just over a week later Western Coal inked a financing agreement with Audley European Opportunities Fund; the deal saw Western Coal issue $40-million worth of senior convertible debentures to Audley investors. In the interim, the lawsuit alleges, company insiders purchased 111,000 shares.

The suit argues the company “knew or ought to have known” that releasing negative news about the company’s viability would depress its share price. Given the company’s pre-existing relationship with Audley – Audley owned 29% of Cambrian Mining, which in turn owned 42% of Western Coal; in addition, Cambrian Mining and Western Coal shared a chairman and director – the lawsuit argues Western Coal’s management ought to have known the company was going to obtain sufficient financing from Audley to meet its financial obligations. As such the suit alleges the management released the negative financial forecast specifically to deflate Western Coal’s share price. (Western Coal has since acquired Cambrian Mining.)

The suit seeks $220 million in damages, of which $20 million is for punitive damages. Western Coal says the allegations are without merit and the company plans to defend itself vigorously. John Hogg, president of Western Coal at the time of the alleged incident, is named as a defendant but was recently replaced at the company’s helm by new president and CEO Keith Calder.

At the end of 2009 Western Coal had $150.1 million in the bank. The company’s share price has moved between $3.15 and $391 in February, near the upper end of its 52-week trading range of 36¢ to $4.42. Western Coal has 323 million shares outstanding.