Cloud Peak Energy (NYSE:CLD) is increasingly looking abroad for growth. Although Asia is expected to drive coal demand over the long term, there are some headwinds investors need to think about.
In 2008, Cloud Peak sent less than 1% of its coal production to Asia. Management is projecting that number to hit 5.5% in 2013. Although this isn't exactly breathtaking growth, it has come at a time when coal demand in the United States has been falling. In 2011, the company sold about 91 million tons of coal domestically, last year that fell to around 86 million. The projection for this year is about that level, or slightly lower.
Clearly, coal demand from Asia is important for Cloud Peak's near-term results. However, to "maximize exports" is a key long-term growth platform, too. That makes sense as the U.S. Energy Information Administration (EIA) notes that exports to Asia have grown from about 7% of the U.S. export total in 2007 to 25% last year. However, they still represent just 4% of Asia's total imports so there's still growth potential.
That said, there are a few headwinds to keep in mind. First, Cloud Peak's largest Asian market is South Korea. That country is relatively mature compared to China and India. Peabody Energy (NYSE:BTU), for example, is expecting 90% of the global demand growth for coal to come from the latter two countries.
So, while Cloud Peak is selling into Asia, South Korea isn't the "sweet spot." That's one reason to favor a company like Peabody, which has material operations in Australia that give it direct access to both China and India. In fact, Peabody is already selling more than twice as much thermal coal from Australia alone to Asia as Cloud Peak's entire operation is.
Transportation costs and infrastructure are behind Peabody's lead. Cloud Peak has to mine its Powder River Basin (PRB) coal and then haul it by train to West Coast ports. It then ships the coal to Asia. There's a great deal of expense in that process that makes PRB coal's relatively low costs head higher quickly. Australia is clearly much closer, so shipping costs are lower.
And, Australia is more geared toward coal exports than the U.S., which has historically used its coal internally. Cloud Peak is using just three ports to send its coal overseas. With more companies looking to follow the same export model, demand for port access is increasing. Increasing demand leads to increasing costs.
From this perspective, industry giant Peabody might be a better option for more conservative investors. In addition to its Australian operations, it also operates out of the PRB, among other domestic coal regions. Basically, anything that helps Cloud Peak will also benefit Peabody to some degree. Moreover, the company has notable metallurgical coal operations, too. Cloud Peak is focused on coal used in electricity generation.
Peabody is projecting full year 2013 sales volumes to be flat to lower than 2012 volumes. And pricing has been weak so far this year. So, 2013 should be a bad one for Peabody. That said, the company is in solid position to benefit as coal markets improve, and year-over-year comparisons should be a lot easier in 2014.
Although Cloud Peak benefits from its relatively low-cost PRB coal, its fortunes are tied to that mining region. On the plus side, coal stockpiles at U.S. electric plants are dwindling, so domestic demand could pick up over the next year or so. The company is also working on access to new export ports that should come on line over the next few years, assuming permits come through. Both would be a big boost for Cloud Peak, but there's more risk here than at Peabody.
A double check?
One company to keep an eye on is Kinder Morgan Energy Partners (UNKNOWN:KMP.DL), which has become increasingly interested in the coal industry. Although best known for its massive oil and gas infrastructure, it has about $450 million worth of coal terminal expansion projects under way. So, Kinder Morgan is helping to get more U.S. coal into foreign markets. Watch for its progress on these efforts.
With its size and scale, Kinder should have no problem executing on these projects. As companies look to tap growing demand abroad, Kinder will not only help spur the process, but it will also benefit from the industry shift. Note, too, that Kinder recently announced plans to create a coal leasing arm. As an opportunistic buyer, this move suggests that coal prices may be nearing a bottom. Midstream oil and gas infrastructure will still be the driving force here, but coal could become an increasingly important business to watch.
Cloud Peak offers investors a growing international profile and focused exposure to cheap PRB coal. These are intriguing attributes that should lead to improved performance in 2014. However, shipping costs and infrastructure are two big issues to watch. Peabody, with direct access to China, India, and mines in the PRB region, is a more diversified option that should interest conservative investors. Kinder Morgan, meanwhile, is providing the infrastructure to move the increasing flow of U.S. coal toward Asia. That's a way to benefit from the trend without having to take on as much direct coal exposure.