The coal miners have had a difficult time, and margins have suffered significantly, especially in the PRB, as no noteworthy production capacity has been idled compared to other regions in recent years. A further complicating factor for Cloud Peak (NYSE:CLD) is that the relevant competitors have gotten rid of a large part of their debts through Chapter 11 and can now happily continue to produce in absence of any financial burden. Even though Cloud Peak has less financial clout compared to the heavyweights Arch Coal (NYSE:ARCH) and Peabody Energy (NYSE:BTU), the company still has a trump card up its sleeve: Exports.
Let's take a look at Cloud Peak Energy's long-term revenue and earnings drivers:
- Production Costs
- Realized Prices
In the recent quarter production, costs have risen significantly more at Cloud Peak than at Arch Coal or Peabody Energy. There are two causes for this: production volume and strip ratio. The significant impact probably comes from the volume of production, which in the first half of 2018 decreased by 4.8 million tons to 23.8 million tons. By comparison, Arch Coal was able to keep costs stable with virtually unchanged volumes. In addition, management repeatedly emphasized that costs increase each year as the strip ratio increases.
The numbers suggest that this happens faster than in the neighborhood - maybe Cloud Peak has hauled too much in the past few years? For example, CEO Colin Marshall has stated in the earnings call in February 18 that there will be a greater increase in the strip ratios in its mines by 2019, before they stabilize again or even experience a little relief. Thus, the incentive of the management is not particularly great to substantially increase the production rate at the current prices.
The pressure on coal prices comes, of course, above all from the use of natural gas, which has meanwhile gained a higher share in electricity production than coal. Although the natural gas price has rebounded significantly from 2016's lows, natural gas still displaces coal. This is not to change soon and substantially, but one can expect some relief. A look at the natural gas storage data of the EIA suggests that utilities will gradually have to switch from natural gas to coal during the next winter, since net injections are rather sluggish and storage levels are low.
Also, natural gas producers seem reluctant to invest in new capacity under $3, as evidenced by the slightly declining rig count. In the medium term, the use of coal should therefore increase somewhat. In the long run, certainly a suppression by renewable energies is to be expected.
The big bright spot for Cloud Peak is international sales. Here, the company has export contracts of 5.5 million tons p.a. via Westshore Terminals, Canada. This amount will increase to 10.5 million tons in 2021 and 2022. In addition, CLD has signed the delivery of more than one million tons (JERA) to Japan from 2020 onwards, increasing the exported coal volume to 11.5 million tons by 2022. Up to now, export earnings have been barely visible as only $5.46 cash margin per ton was generated on exported coal last quarter and even less before.
Should the international coal price stabilize at the current levels, cash margin will increase to $15. So, if the price becomes visible in the new shipments, the company can earn up to $20 million EBITDA per quarter starting in the fourth quarter 2018. Since some new coal-fired power plants are still being completed in SE-Asia, and the resource companies have been holding back on the development of new coal mines in recent years, a stable international coal price is in the offing.
CEO Marshall revised the midpoint earnings guidance of EBITDA down to $75 million. Although a downward revision, this is not all bad, since the company expects to generate $56.1 million in the second half after $18.9 million in the first half. The figures for the second half of 2018 can most likely be extrapolated for 2019 and I would not be surprised if the company had an EBITDA of more than $120 million in 2019 with $50 million in cash generation. With a stabilizing domestic market, it could even be more. All in all, the current dip in the share price offers a good buying opportunity for long-term investors and swing traders, respectively.
Not mentioned in this article are the speculative views of a possible consolidation of PRB companies or a possible sale of Cordero Rojo and Antelope mines, so that the company can focus on the development of the Big Metal project and the highly profitable export market.
Disclosure: I am/we are long CLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.