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By Jeremy Glaser | 01-14-2011 02:45 PM

Mine This Firm's Stock and Bonds for Value

Cloud Peak is probably one of the most attractive names in the commodity space today, says Morningstar's Mike Tian.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Commodities have been on the top of a lot of investors' minds recently, and our analyst staff has discovered an intriguing bond pick in the coal space.

I'm here today with Dan Rohr and Mike Tian to take a closer look at Cloud Peak Energy.

Gentlemen, thanks for talking with me today.

Mike Tian: Thanks for having us.

Daniel Rohr: Thanks, Jeremy.

Glaser: So, Mike, let's just take a first step and just look at what's happening with the coal industry in general? How does demand look, how is supply? What's happening in that sector?

Tian: Coal is definitely booming right now. I mean, the basic story, as with a lot of other commodities is that, China, India are importing more and more of this stuff, and we can barely make enough to keep pace. And on top of that, we have torrential rains in Australia and Indonesia thanks to El Niño, and that's flooded a lot of mines and forced closure of a lot production out there.

And accordingly perhaps, no surprise, coal prices are something like 40% higher since last fall for Asian thermal prices, and metallurgical prices are near their all-time peak of almost $300 per metric ton.

Glaser: So, has Cloud Peak been able to benefit from this rise in prices yet?

Tian: Well, actually for Cloud Peak, they have not been able to directly benefit from the rising prices because all their mines are in the region of the world known as the Powder River Basin, which is in Wyoming. So, this place does not have great transportation links with rest of the world. So, they have not been able to export directly to China and India and places like that and get immediate benefit from rising margins.

More importantly, their management has also been rather prudent, and they've contracted out 2011 prices, pretty much committed at lower levels and current levels. However, over the next year, we think the rising prices will definitely be a big tailwind because not only are the higher Asian prices going to ripple through the rest of the world markets and drag U.S. pricing up with it, but also as lower-price contracts roll off and they commit next year's production to higher levels, you should see a natural margin accretion without them having to do anything.

Glaser: So, Dan, when we look at Cloud Peak's balance sheet, when we look at the bonds that you're finding attractive right now, why Could Peak versus any of the other coal miners that might be seeing immediate benefits from this price increase?

Rohr: Well, we regard Cloud Peak as one of the highest-quality credits in coal mining. One of the things about the Powder River Basin where Cloud Peak's assets are is it's a very low cost place to operate, to dig the black stuff out of the ground.

So, that cash flow volatility dampening mechanism is favorable, in our opinion, from a credit perspective. Second reason we like Cloud Peak is, there is not a lot of leverage on the books. I think 12 trailing months to end of 3Q, you're looking at maybe 1.7, 1.8 debt-to-EBITDA, and that's gross debt. In addition the company has got about $300 million in cash, so net debt-to-EBITDA is quite a bit more favorable.

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