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A Square Miss at Cloud Peak Energy

Zacks Equity Research

Prominent coal producer Cloud Peak Energy Inc. (CLD) reported lackluster performance in the second quarter of 2012. The company’s earnings were 34 cents per share in the reported quarter compared with 72 cents per share in the year-ago period. Cloud Peak Energy’s earnings also fell short of the Zacks Consensus Estimate of 35 cents.

The earnings underperformance can be attributed to lower electricity demand due to consumers’ preference for soft priced natural gas, mildly offset by efficient control of operating costs.

GAAP earnings in the second quarter were 55 cents per share versus $1.56 per share a year ago. The difference between GAAP and pro forma earnings of 21 cents in the reported quarter is due to a gain from derivative financial instruments.

Total Revenue

Cloud Peak Energy recorded aggregate revenue of $343.2 million, down 11.5% from the year-ago revenue of $387.7 million. The revenue downturn resulted from decline in coal sales due to higher utility stockpiles accumulated during the warmer winter months compounded by reduced shipments from the Spring Creek mine due to flooding of the company’s MERC terminal on Lake Superior during mid-June 2012.

On the overseas front, Cloud Peak Energy’s export to Asian countries during the quarter was roughly 1 million tons reflecting a slight decline on account of low margin contracts in the Ridley Terminal and shrinking of capacity at the West Shore terminal resulting from expansion shutdown of one of the two facilities early in the second quarter.

Total revenue for this western US coal company lagged the Zacks Consensus Estimate of $360 million.

Acquisitions & Agreements

A pure player in the Powder River Basin (“PRB”), Cloud Peak Energy acquired neighboring Wyoming based coal company, Youngs Creek Mining Company, LLC and other related coal and surface assets for $300 million during the inception of the second quarter. Of the $300 million, $195 million is assigned for lease of approximately 450 million tons of coal. The high quality purchase is expected to meet the increased export demand from the Pacific Northwest to Asian countries.

The company also entered into an agreement with the Crow Tribe of Indians for gaining exploration rights and exclusive options to lease and develop 1.4 billion tons of Northern PRB (“NPRB”) coal in the Crow Tribe’s reservation land in Southeast Montana.

Operational Highlights

On the cost side, the company’s performance was favorable with operating expenses dropping 9.1% to $284.5 million from $313.0 million in the year-earlier period. The company’s effective management of costs in the face of reduced demand during the quarter laid the path for declining expenditures. Cost of product sold decreased 8% to $266.1 million from $288.0 million at the end of June 2011. In spite of cost containment, operating income slid down to $59.0 million from $75.0 million in the prior-year quarter owing to top-line weakness.

Adjusted Earnings before Interest, Tax, Depreciation and Amortization (:EBITDA) in the second quarter of 2012 stood at $65.6 million versus $88.3 million in the prior-year quarter.

Interest expense at the end of June 2012 was $8.0 million versus $8.5 million at the end of second quarter 2011.

Financial Update

Cloud Peak Energy maintained a strong cash balance which enabled the company to acquire Youngs Creek assets during the quarter. Cash and cash equivalents as of June 30, 2012 were $121.6 million compared with $404.2 million as of December 31, 2011. The company’s total available liquidity of $722 million indicates a solid balance sheet position.

Cloud Peak Energy generated cash from operating activities of $81.3 million for the six months ended June 30, 2012 compared with $119.0 million for the six months ended June 30, 2011.

Guidance for 2012

Cloud Peak Energy estimates coal shipments in the range of 90–93 million tons. The company has contracted to sell 92.6 million tons for 2012 out of which 90.5 million tons are contracted for sale at a realized price of $13.34 per ton. The company expects summer weather to be a top-line catalyst albeit subject to gas production and prices.

Adjusted EBITDA is forecast in the band of $300–$330 million. Depreciation, depletion and accretion expenses are expected to be in the range of $105 million to $115 million.

The company has proposed capital expenditures of about $60 million to $80 million for 2012.

Peer Comparison

Arch Coal Inc. (ACI), the closest competitor of Cloud Peak Energy, reported pro forma loss of 10 cents per share in second quarter 2012, in contrast to earnings of 44 cents per share in the year-ago comparable period. This was primarily due to lower sales volume related to decline in shipments from PRB operations. The reported loss was, however, narrower than the Zacks Consensus Estimate of a loss of 18 cents per share.

Arch's total revenue in the reported quarter was $1,063.5 million, up 8% from $985.5 million in the year-ago quarter. Quarterly revenue surpassed the Zacks Consensus Estimate of $1,020 million.

Our View

Cloud Peak Energy’s dull top- and bottom-line performance can be attributed to the current depression in the coal market which is facing stiff competition from natural gas. However, this downturn is expected to reverse as growing demand from Asian markets will drive up coal sales in the coming years.

The company’s recent acquisition of Youngs Creek will fortify its holdings in the PRB and meet the demands for both domestic and international customers. Also, the hot summer months will perk up demand for electricity, boosting the company’s top-line position.

Nevertheless, the cumulative effect of pro-environment regulatory decisions will increase the company’s costs and lead to decline in coal demand as Cloud Peak Energy chiefly engages in thermal coal production. Additionally, uncertainty related to the company’s agreement in the NPRB and risks associated with hedging programs are a matter of concern.

Cloud Peak Energy currently has a Zacks#3 Rank implying a short-term Hold rating.
Based in Gillette, Wyoming, the company through its subsidiaries engages in coal mining operations in the PRB. It produces and sells sub-bituminous thermal coal with low sulfur content primarily to electric utilities.

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