2023-12-21 09:16:31 ET
Summary
- Alliance Resource Partners' stock is ending the year near where it began as lower coal prices end its rally.
- The coal market has cooled down in 2023 as natural gas prices have become cheaper globally.
- Despite the decline, ARLP's performance has been in line with expectations, making it worth further examination.
- Based on its contract data, I project its 2024 EPS close to $4, with that figure falling to $1 by 2026, given no improvement in spot prices.
- ARLP stock is likely overvalued today if we assume thermal coal prices will not rebound, which is possible due to geopolitical and energy market issues.
Around the beginning of this year, I published a warning regarding Alliance Resource Partners ( ARLP ) in "Alliance Resource Partners: Profits May Reverse In 2023 As Coal Prices Plummet." Before then, I was bullish on the stock beginning around early 2020, given my view that coal would rise due to its low price and volatility in the natural gas market. However, in January, I downgraded ARLP to "hold" because it appeared likely that coal prices would reverse as natural gas became much cheaper. Since then, ARLP has lost 13.2% of its value, which is only a ~1% net loss if its dividend is accounted for.
Given that ARLP has continued to perform as expected, I believe it is an excellent time to take a closer look at the company. The coal market is much cooler than in 2022, as natural gas has become inexpensive in most of the world. Thermal coal has lost staggering value this year but remains materially higher than before 2020. Alliance Resource is also earning decent income today because of its long-term price contracts on the commodity. As those contracts roll forward, the company will likely experience a moderate income and cash flow decline. As a Limited Partnership, its dividend will ultimately follow its income, meaning it should fall in 2024.
Given that coal economics have continued to deteriorate, there is some risk that ARLP will be overvalued today. The stock still trades at a dividend of 14% and a "P/E" of 3.9X, but those figures are likely overestimated given contracts will roll at lower prices, offering lower profit margins and total sales. As such, to value the company, we will need to consider the company's immediate profit outlook as well as the long-term economics of the thermal coal market.
Coal Has Great "Geopolitical Hedge" Value
Fundamentally, the global energy market is moving away from coal. Although it is relatively cheap and highly abundant, it is not as clean as natural gas. Although coal can be made cleaner through recent technological innovations, there has been a lack of effort to implement these technologies on a sufficiently large scale. In most Western countries, coal is essentially becoming a "backup" energy source that can be used when natural gas supplies run low. US coal consumption levels are back down after rising with natural gas from 2020 to 2022. That said, US coal exports are higher while production is relatively flat. See below:
The US is still exporting coal at a decent pace. China and Europe have had increased coal demand in recent years, which persists today. One primary reason for this was initially decreased production levels of most fuels during the COVID era. However, the war in Ukraine has added pressure by limiting Europe's natural gas supply, causing more liquified natural gas to flow to Europe instead of China . As such, China and other Asian countries have become more dependent on coal, while Europe has also seen an increase in coal demand.
While most countries prefer natural gas over coal, it is far easier to ship coal than natural gas. Natural gas pipelines have also been targeted in numerous recent geopolitical crises. A great deal of European liquified natural gas comes from Qatar through the Red Sea, accounting for about 8% of global supplies. Today, due to attacks on civilian vessels, most of that LNG will need to flow around Africa, which, from the standpoint of Qatar, is a much longer route that should result in higher LNG import costs for Europe. Most shipping stocks have seen tremendous profit growth due to this recent geopolitical crisis.
The net impact of this specific issue on the coal market is unclear. That said, any increase in natural gas prices will positively impact the thermal coal market. More importantly, it adds weight to my long-term argument that coal is the world's primary "emergency" power supply. As countries between Europe and the Middle East continue to face difficulties, Europe will likely continue to rely on US energy exports to make up for volatility in Middle Eastern and Central Asian energy trade markets. Of course, we cannot expect coal to rise in value until we also see natural gas rise because gas is the preferred power source. Despite volatility, natural gas is comparatively cheap today compared to 2022. See below:
NC Coal Price vs. EU and US Natural Gas (Trading Economics)
This coal price index tracks the Australian thermal coal price, which is different from that of the US; however, all global thermal coal prices will tend to trade similarly. The Australian price index has been slightly more volatile because changes more directly influence it in the Chinese market. That said, it is evident above how thermal coal closely tracks global natural gas prices. In the US and EU, natural gas has fallen back to pre-crisis levels over the past ~18 months. These fuel prices are still on the high end of their historical range but no longer behave as if there is a fuel shortage. Given this, it is likely that Alliance will see its income and sales decline in 2024. That said, given geopolitical issues, I would not be surprised to see coal eventually return to crisis levels due to its importance as a backup fuel source.
Profit Outlook for Alliance Resource
The current analyst consensus places Alliance's 2024 EPS at $5.07, falling to $4.58 in 2025. Those figures show a slight decline from its current TTM EPS level of ~$5.56. That said, only one to three analysts are behind these estimates, meaning they're highly subject to bias and are potentially based on older coal price outlooks. To value ARLP, we must consider its contracted revenue and its long-term potential revenue, given lower coal prices.
During the first three quarters of 2023 , Alliance earned an average quarterly revenue from coal sales of $562M, with robust consistency each quarter. On average, it had about $85M in total other sales (primarily royalties) each quarter, again with good consistency. On page 18 of its 10-Q, it had total contracted revenues for 2024 of $1.69B or $422M per quarter and around half that for 2025 ($795M). As mentioned in its investor call, its 2024 contracts were for 27.3 million tons, compared to its total production outlook of around 35 million. Dividing those figures, we arrive at an average contracted price per ton of ~$62 for 2024, down from about $65 for 2023.
Thermal coal prices are now around $45 per ton in the Illinois Basin market, down significantly over the past two months. As such, I estimate a total revenue of ~$346M on the ~7.7M in tonnage that was not contracted by the end of Q3. This gives us an estimated coal revenue of ~$2.04B, adding its contracted and non-contracted figures. The company's adjusted EBITDA expense per ton is around $40 this year, so we can likely project that figure into 2024. With 35M in estimated production, that equates to an EBITDA expense estimate of ~$1.4B. So, its EBITDA on profit for coal in 2024 should be around ~$640M (or revenue estimate minus cost estimate).
From pg. 29 of its 10-Q, we can see its segment-adjusted EBITDA from its royalties is approximately $46M per quarter, or ~$183M per year. Royalty income levels are usually relatively consistent, so I will add the EBITDA figure to the coal one to arrive at a total estimated adjusted EBITDA outlook for 2024 of ~$823M. Subtracting depreciation and interest (extrapolating TTM figures - $309M total), its pre-tax income outlook 2024 would be ~$515M. As an LP, virtually all of that income should not be taxed by the company. This translates to a 2024 EPS outlook of $4.04, which I believe is more reasonable given the declines in thermal coal prices.
Even then, the company's forward "P/E" would be around 4.95X, which is still very low. Its dividend should decline slightly, but its forward yield is likely still around 12%, which is good. That said, if we imagine thermal coal continues to trade at its current $45 to $50 per ton level, the company will hardly break even on its production. If it were to sell all its output at these prices, its total EBITDA on coal sales would likely be closer to $262M (~$7.5 marginal EBITDA profit X 35M) per year. Adding other estimated EBITDA and subtracting depreciation and interest, this income projection would only be around $136M per year, giving it a long-term EPS outlook of just ~$1.08, warranting a much lower long-term dividend yield of about 4% and a "P/E" of ~18.5X. These estimates assume its contract prices eventually converge toward the spot market, which would not be until ~2026 but would essentially be seen by 2025 unless prices rise.
The Bottom Line
If we only consider Alliance's 2024 outlook, it could still appear undervalued today, given that its "P/E" would be below 5X based on my EPS estimate. Its revenue may be slightly higher than my 2024 estimate if it creates contracts on its (as of Q3) non-contracted production above the current spot price. That said, I do not believe the variation should be very significant.
However, from a long-term standpoint, ARLP appears to be potentially overvalued today. If its contract prices eventually converge toward spot prices, then its EPS should decline to ~$1 per share based on its geographic area's current spot price range. One analyst gives ARLP a 2025 EPS outlook of $4.58 (the only analyst projecting its 2025 EPS). To me, that is extremely unlikely, with that figure likely being closer to $2, given only a small portion of its revenue was contracted at attractive prices by the end of Q3. Beyond 2025, I believe its EPS will be closer to $1, given stable spot prices, and potentially lower if the company's production costs rise.
Based on these longer-term EPS projections, ARLP would almost certainly be overvalued today as a coal producer should not trade at a "P/E" above ~8X, given the expected long-term decline in coal demand. Of course, while that has been the status quo for coal companies, it is possible that coal will remain popular longer than many assume. To me, ARLP is overvalued today based on the 2025+ horizon. That said, it is also very possible that thermal coal spot prices rebound higher by 2025 due to geopolitical and economic pressures. Thus, while I would personally take profits on ARLP today, I am not particularly bearish on the stock because it may have upside potential as a hedge against geopolitical and energy market issues.
For further details see:
Alliance Resource Partners: Dividends Will Plummet In 2025 Unless Coal Rebounds Soon