The Bull Case on Powder River Basin Coal Producer Cloud Peak
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While I'm not invested in coal producer Cloud Peak, (NYSE: CLD), it has proven to be a strong company. A knock on Cloud was its over-exposure to the Power River Basin (PRB). Given that 100% of Cloud's production is from the PRB, that concern was, and still is, warranted. Other knocks were that it had a short "reserve life" (coal reserves divided by annual production) and zero coking coal. When crude oil prices spiked in mid-2008, Cloud was hit with unhedged diesel. Finally, last year shareholders were not happy when peers Arch Coal, (NYSE: ACI), Alpha Natural Resources, (NYSE: ANR) and Walter Energy, (NYSE: WLT) made transformational acquisitions while Cloud stood idly by. Management was criticized as being overly conservative.
In the past 18 months most of these flaws have been remedied. First, the acquisition spree among peers turned out to mark the top of the market. Alpha's acquisition of Massey Energy was controversial from the start. In hindsight Alpha way overpaid for mining operations that were in worse shape then they realized. Recently Alpha took a $2.5 billion non-cash write-down, largely of legacy Massey assets and goodwill.
Arch's acquisition of Intl. Coal was no better. It left them stuffed with debt, $4.5 billion at last count. In addition, Arch became the proud owner of more central Appalachia (CAPP) assets. Today, you can't give away thermal coal assets in CAPP. As an indication of how bad the CAPP market has become, Patriot Coal filed Chapter 11 bankruptcy due to their thermal CAPP exposure.
Through luck or savvy management, I think the latter, Cloud avoided all of that heartache. By sticking to its core PRB operations, management is looking anything but naive. Instead of acquisitions, the company built up a large pile of cash. At 3/31/12 Cloud had $585 million of cash and short term securities vs. total debt of $885 million, for a Net Debt/EBITDA ratio of just 1x. Arch's Net Debt/EBITDA ratio was about 5x on that date.
Armed with cash and a pristine balance sheet, Cloud acquired from Consol Energy a block of northern PRB coal for $170 million. More recently, Cloud reached a tentative agreement with the Crow Tribe of Indians to explore, lease and develop up to 1.4 billion tons of northern PRB coal in southwest Montana. This puts to bed the concern about a short reserve life.
Concentrating on the PRB has made Cloud lean and mean, with the lowest costs in the basin. Cloud is actively pursuing west coast and Gulf of Mexico export options with a private company named Ambre Energy. If successful, Cloud will effectively diversify away from the PRB via exports to Asia. Thus, another shortfall is being addressed.
Cloud has generated solid and consistent earnings over the past three years. EBITDA is running at about $300 million per year. Interestingly, EBITDA margins on the company's non-sexy thermal coal are looking pretty good relative to peers. The main reason I don't own Cloud is because I don't see big upside in the stock at current levels. Cloud's stock has fallen far less than peers, so it probably doesn't have as much room to rebound as companies like Alpha or Walter Energy.
MockingJay2011 owns shares of Alpha Natural Resources and Walter Industries. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.