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Why This Coal Miner Breaks the Negative Industry Trend
Posted by: Patricio Kehoe (IP Logged)
Date: December 9, 2013 04:31PM

Demand for coal has been quite stagnant as of late, largely due to strict emissions regulations in the U.S., along with declining prices for its substitute: natural gas. However, despite strong competition from natural gas, and an increasingly unattractive market situation, not all is lost for coal miners.

The coal stemming from the Powder River Basin (PRB) region is expected to experience a significant increase in prices, as it presents itself as a cost-effective option for generating electricity. Firms operating in this area, such as Cloud Peak Energy Inc. (CLD), could thus once again become a profitable investment option. Let’s take a close look at this company, and why it is poised to continue growing in years to come.

Low Cost Structure and a Nag for Forward Selling of Production

Cloud Peak Energy has grown to be the third-largest coal mining firm in the U.S., with an annual output of approximately 100 million tons, thanks to its activity in the PRB. The firm not only has a distinct advantage over coal-mining rivals such as Consol Energy Inc. (CNX), and Peabody Energy Corporation (BTU), and is also well positioned to compete with natural gas. Very low extraction costs, which hover at levels below the $10 per ton mark, are essential to Cloud Peak Energy’s strategy.

Being the lowest-cost coal producer in the world has allowed the company to generate large operating margins, and remain profitable in a very hostile market. In addition to its low-cost profile, cost control has been another key element in Cloud Peak Energy’s success. Looking forward, the focus on cutting costs further is bound is generate even larger margins for the company, which already has a very healthy balance sheet. Yet cost reduction is not the only advantage this coal miner exhibits over rivals.

In order to deal with the fluctuating prices, Cloud Peak Energy has opted for a forward-selling strategy, which has allowed it to extract profits, despite depressed coal prices. Since production output is sold years in advance, the firm has surely not suffered from the decline in prices the same way as its rivals. And, despite not being able to benefit from sudden spikes in coal prices, this prudent strategy has certainly paid off.

Outperforming Industry Rivals

Taking a closer look at the performance of industry peers, supports my enthusiasm for the PRB-based coal miner's forward-selling strategy and low-cost profile. Whereas rival Consol Energy has seen free cash flow levels drop into the negatives, and debt levels rise, Cloud Peak Energy has actually been able to reduce the amount of money it owes. Returns on invested capital tell a similar story: Consol Energy has a 4.8 percent ROIC, whereas Cloud Peak Energy offers 14.4 percent, almost triple its value. Another rival, Peabody Energy, is also having trouble with stagnated demand for coal: The firm has seen operating margins reduced to 2.1%, as net losses continue to constrain its ability to offer shareholders higher ROIC. Unlike these two troubled coal miners, Cloud Peak Energy has a very comfortable operating margin of 15.9 percent, sustained by growing cash flow levels.

Good Value for Money

Fiscal conservatism, forward selling of production and operations in the low-cost PRB region, have allowed Cloud Peak Energy to rise above its industry peers. Even the competition from the natural gas sector has not been sufficient to halt the firm’s growth prospects. Also, the purchase of over 1 million shares of common stock by the men at Manning & Napier Advisors Inc. is reassuring. Overall, I feel bullish regarding this firm’s future, as it offers a low-cost product, which presents itself as a great alternative for natural gas. Also, since the stock is trading at 16.5 times its trailing earnings, it can be purchased at an equal value relative to the industry average.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.


Stocks Discussed: CLD, CNX, BTU,
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