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With the natural gas glut having crushed the coal space, investors are keen to pick up bargains. Perhaps too much attention is being given the high cost and leveraged names. When industry downturns occur, the strong take from the weak. Consider Cloud Peak Energy (CLD) in preparation for a cyclical coal upswing.

Cloud has a humble beginning. In the 1990s mining giant Rio Tinto (RIO) began mining coal in the Powder River Basin in Wyoming and Montana. Needing to shore up their balance sheet following the financial crisis, Rio Tinto sold smaller assets. One of those assets was Cloud. Cloud went public in 2009 and in 2010 Rio exited their remaining stake.

As the only pure play Powder River Basin coal company, Cloud is in an advantageous position. PBR coal production is low cost and in industry downturns low cost operators take market share from high cost, struggling companies. Additionally, Cloud's operating margins are superior even within the PBR. First half 2012 average cost of product sold per ton was $9.93 with an average selling price of $13.21.

Importantly and unique to the coal sector, Cloud has a clean balance sheet. Cloud ended the second quarter with $221.8 million in cash. Outstanding debt consists of $600 million in notes, half of which is due in 2017 and half in 2019.

Cloud looks to generate $200 million in free cash flow this year from operations, at perhaps the trough of an industry cycle. EBITDA should be $300 to $330 million in 2012, down from adjusted EBITDA of $351.7 million in 2011. With a market cap of $1.07 billion and growth ahead, the valuation looks good.

Meanwhile, competitors are struggling. Arch Coal (ACI) will not have 2012 free cash flow after minimal capital spending and interest service. Arch vaguely spoke about selling unnamed operations to raise cash against $4 billion in debt. Yet Cloud in the second quarter added Young's Creek as another development asset. Cloud is positioning the company to export coal to Asia as a part of the coal super-cycle.

The coal industry continues to be hit hard by the natural gas (UNG) oversupply. But I am watching carefully for green shoots. Hydro production is poised to fall after the mild winter and drought conditions. Very high coal inventory levels have begun to be drawn down with the hot summer. High cost producers have closed mines. Perhaps emerging market growth will rebound.

When natural gas production finally does fall from stubbornly high levels, look for coal to rebound strongly. This shoulder season may be particularly difficult to navigate, perhaps providing bargains to the patient investor. I will be avoiding the weak companies. Cloud Peak Energy is among the strongest industry participants.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Perhaps the shoulder season this fall will be the time to get long the coal sector.

Source: Cloud Peak Energy: Strong PBR Coal Play