Although 2011 was not an especially strong year for any industrial commodity, it was a pretty lousy year for coal. Export volume stayed pretty high, but momentum was sapped by weakness in met coal and a general cooling-off of what was probably far too much investor enthusiasm to start with. As is almost always the case, it wasn't different this time.
That being said, investors may yet want to bone up on Cloud Peak Energy (NYSE:CLD). As a pure play on the closest thing to clean coal, Cloud Peak could see stronger demand in both domestic and export markets, as well perhaps as interest from larger buyers. (For more, see Earning Forecasts: A Primer.)
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No Powder Puff
Cloud Peak Energy used to be the North American coal operations of Rio Tinto (NYSE:RIO) and now, post-spin off, is its own independent company. Cloud Peak is the third-largest coal producer by volume and the largest pure-play in Powder River Basin coal.
Powder River Basin coal is one of those examples of how nature doesn't give something for nothing. Although this coal is cleaner in terms of its sulfur and mercury content, it contains less energy - about two-thirds of the energy of coal from Appalachian or Illinois Basin mines. This sets up a somewhat complex pricing mechanism between the cost of transportation (since PRB coal is less energy-dense), the cost of environmental compliance, the cost of production, and the cost of alternative fuel sources.
Structural Advantages ... and Disadvantages
To the best of my knowledge, there are no underground PRB coal mines and no need for them. Since this is all surface (open pit) mining, the cost of production at Cloud Peak is much lower than that at companies like CONSOL (NYSE:CNX) or Alpha Natural Resources (NYSE:ANR) that operate underground mines.
On the flip side, Cloud Peak is more exposed to the impact of shipping costs. There are few major utility customers in the vicinity of the Powder River Basin (which is predominantly in Wyoming) and this coal has to be carried a greater distance on rails owned by Union Pacific (NYSE:UNP), Berkshire Hathaway (NYSE:BRK.A, NYSE:BYK.B) and so on.
There's also the risk of alternative substitution. PRB coal is cleaner to burn, but companies like General Electric (NYSE:GE) and Siemens (NYSE:SI) offer technologies that allow utilities to either burn Appalachian or Illinois coal (by installing scrubbers) more economically or build new plants entirely that use natural gas as the fuel source.
Is Cloud Peak Built to Last?
The biggest concern for potential Cloud Peak shareholders may lie in the structure of the company itself. Cloud Peak has fairly limited reserves - only about 10 years' worth based on recent production volumes. What's more, the company's debt-to-capital ratio is already as high as Arch Coal's (NYSE:ACI) and higher than the likes of Alpha Natural or Peabody (NYSE:BTU).
This could limit the company's ability to continue producing at the most desirable levels, but it could also make it a target for one of those larger players - Peabody, Arch, and Alpha Natural are all active in the PRB area and there could be some synergies to folding in Cloud Peak's assets.
The Bottom Line
Although there are more than a couple of black marks against coal today, investors have often done best by buying in when coal conditions looked worst. Given Cloud Peak's iffy reserve base, the company does not deserve a premium multiple. Even still, assigning just a 'five' multiple to 2012 EBITDA estimates suggests that the stock may be underpriced by more than 30%. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)
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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.