Last week I met with Powder River Basin coal producer Cloud Peak's (CLD) head of Investor Relations. I learned that Cloud Peak is defensively positioned in this severe coal market downturn. The knocks against Cloud have been 1) short reserve life, 2) negligible exports, 3) no coking coal, 4) unhedged exposure to diesel fuel, and 5) lack of production growth. A year ago, those factors were a drag on sentiment, Cloud wasn't sexy enough in a bullish market. Today, sexy is out, and prudent is in.
Cloud Peak is sitting on a mountain of cash, $479mm at 12/31/11. As a percentage of its market cap, it's substantially more than most peers. The company has $600mm of long-term debt comprised entirely of 2 bonds that mature in 2017 & 2019. Net debt to EBITDA is well under 1.0x, giving CLD a strong balance sheet. By comparison, near-term debt maturities and/or elevated interest expense have investors in James River, (JRCC), Patriot Coal, (PCX), Alpha, (ANR) and Arch Coal, (ACI) unhappy. Even Peabody, (BTU) is thought by some to be a bit stretched after the acquisition of Australia's Macarthur Coal.
Cloud has proven to be a steady producer. EBITDA in the 3-yr period from 2009 to 2011 ranged from $321mm to $352mm and averaged $322mm. This compares company guidance of $300mm-$370mm this year. Despite my very bearish view of the coal sector, my analysis of Cloud Peak's fully contracted position suggests that the company will be able to comfortably reach the lower end of guidance. With a liquid balance sheet and steady production, it should be just a matter of time before Cloud makes a shareholder friendly move. Another observation worth noting is that Cloud's performance is suffering far less than peers.
For example, using data from one of my favorite analysts, Lucas Pipes of Brean Murray, I compared Cloud's cash margin to peers Arch, Alpha, Consol Energy, (CNX), and Patriot. For 2012, Pipes forecasts a cash margin of 29% for CLD vs. a peer average of 25%. With its excess cash, Cloud is contemplating buying back shares, making accretive acquisitions and instituting a dividend. Buying back stock seems to make a great deal of sense, but Cloud did not repurchase any shares in either 2010 or 2011. A reason cited for this is that the free float and daily trading volume is too low.
As mentioned earlier, Cloud's earnings and balance sheet make the Company ripe for a dividend. Peer PRB producer Arch Coal's stock is currently yielding 3.6%. CLD could comfortably pay a 2% dividend. A $0.36 annual dividend would cost $22mm. The market reaction to a dividend would be favorable, and even more favorable to a stock buyback. I believe that the Company could repurchase 5% of shares in an orderly fashion without materially reducing trading liquidity. Over the course of a year, assuming 260 trading days, Cloud could retire 5% of its float with the repurchase of just 1% of its daily trading volume.
Over the past year, Cloud has made strides in addressing some of the knocks against them. The Company's reserve life has grown to ~ 14 years, still not great, but better. Given Cloud's balance sheet, the Company can afford to acquire additional reserves. Cloud Peak exported 5mm tons last year, up from just 1mm tons 2 years earlier. While the Company has not exhibited production growth, that's hardly a hinderance today with peers cutting production left and right. Cloud is in the enviable position of being able to make acquisitions when asset prices are low.
Speaking of acquisitions, a year ago it appeared that Cloud was missing the boat. However, in hindsight, Alpha paid too much and inherited more trouble than they bargained for in Massey Energy. Arch paid too much for Intl. Coal and can't be that thrilled about the acquired thermal coal assets in central Appalachia. Walter, (WLT) paid too much for Canada's Western Coal, and is still struggling with slow organic growth and very high costs at Western. Perhaps Cloud Peak wasn't missing the boat at all.
Anyone who's read my articles in the past month should know that I'm very bearish. However, my meeting with Cloud Peak was enlightening. If Cloud announces a share repurchase plan, I think the stock will outperform peers. As a defensive play and a Company that should, at the very least, institute a dividend this year, Cloud has less downside risk in this volatile market.