2023-12-13 11:21:52 ET
Summary
- Coal prices are rising, leading to a comeback for the coal industry and benefiting Alliance Resource Partners.
- Alliance Resource Partners is a diversified natural resource company focused on coal production and marketing.
- The company has a healthy balance sheet, strong free cash flow, and is currently offering a 15% dividend yield.
Introduction
It's time to talk about Alliance Resource Partners ( ARLP ) , a fascinating company I have never covered on this website or anywhere else.
In addition to getting many requests, I wanted to dive into this income generator from one of my favorite regions in the U.S. that I have never visited - coal country.
I have visiting Appalachia on my to-do list. I'm not sure if I will get to it in 2024, but I hope it won't take too long.
What fascinates me about Appalachia is its part in the American industrial revolution. Without coal from that region, America would never have been able to generate the wealth it has now. Like every developed nation, coal was, and still is, the backbone of the economy.
Unfortunately, just like the German Ruhrgebiet, the transition away from coal has done a number on employment and prosperity in the region.
Using 2013-2017 data (not a lot has changed since then), we see that Appalachia (especially West Virginia and Kentucky) is home to some of the poorest counties in the nation.
While I am a supporter of clean energy (I love nuclear energy and natural gas as a transition technology), I do not support what has happened to the coal industry.
The transition has gone too fast for many people, which has also resulted in higher energy prices.
Currently, we're witnessing the same in the oil industry.
The good news for these regions is that coal is making a comeback.
Although prices have come down meaningfully since last year, benchmark futures like Newcastle Coal are trading well above pre-pandemic prices.
TradingView (ICE Newcastle Coal)
In addition to geopolitical issues like the war in Ukraine, which has increased Europe's dependence on importing natural gas and coal, we're seeing lower production growth rates in natural gas, the biggest competitor of coal, as the shale revolution is running out of steam.
This is what commodity specialists Goehring & Rozencwajg wrote in a recent report (emphasis added):
Over the past decade, no industry has been more capital-starved than global coal . And yet, coal demand continues to confound skeptics by displaying unexpected strength. Coal-related equities literally “caught fire” in the third quarter. The S&P 1500 Coal & Consumable Fuel Index surged 55%, the best-performing commodity-related equity group. For those unencumbered by ESG pressures, we continue to recommend coal equity exposure. From through to peak, coal equities have been the best-performing sector in every commodity bull market since 1900. This pattern seems to be repeating itself . Since June 2020, coal equities have advanced almost 2000%, trouncing the 110% return of the S&P North American Natural Resource stock index, the 70% return of the S&P Global Natural Resources stock index, and the 46% return of the S&P 500.
As I am bullish on both natural gas and crude oil (on a long-term basis), I also like coal.
According to G&R, the coal industry has been facing a shortage of capital.
However, despite the fact that the U.S. is expected to continue reducing its reliance on coal, high global demand and reduced competition from natural gas should enable coal prices to remain high for an extended period of time.
This is great news for Alliance Resource Partners.
Alliance Resource Partners?
Alliance Resource Partners, whose largest shareholders are Joe Craft and his wife Kathleen Mowry, is a Master Limited Partnership, which means it issues a K-1 tax form. It is not taxed as a regular C-Corp, which a lot of income-oriented investors prefer.
It is also why shares are called "units" and the dividend is a "distribution."
Established as an MLP in 1999, the company is a diversified natural resource company engaged in coal production and marketing, as well as oil & gas mineral interests across strategic regions in the United States.
The company focuses on maximizing the value of its existing mineral assets, including coal mining operations and leasing of oil & gas mineral interests.
ARLP also positions itself as a reliable energy provider for the future by pursuing opportunities in energy and related infrastructure.
Nonetheless, its bread and butter is coal.
ARLP is the second-largest coal producer in the eastern United States, operating seven underground mining complexes in various states, including Illinois, Indiana, Kentucky, Maryland, Pennsylvania, and West Virginia.
In other words, this goes well beyond Appalachia.
The company divides its coal operations into two regions: Illinois Basin and Appalachia, marketing coal to major domestic and international utilities and industrial users.
As of December 31, 2022, ARLP boasts approximately 580.7 million tons of proven and probable coal mineral reserves and 1.17 billion tons of measured, indicated, and inferred coal mineral resources.
ARLP sells coal primarily for electric power generation and steel production.
Duke Energy ( DUK ), one of my largest holdings, accounts for more than 10% of the company's annual revenue.
The company has entered into long-term coal supply agreements, fostering stability in sales volumes and prices. Approximately 85.0% and 65.6% of its sales tonnage and total coal sales, respectively, were made under long-term contracts in 2022.
ARLP engages in export transactions, reaching end-users in Europe, Africa, Asia, North America, and South America. Export tons represented about 12.5% of tons sold in 2022, indicating a presence in international markets.
Where's The Juice?
Looking at its long-term stock price, we see a massive decline when energy prices took a hit in 2014 and 2015. After that, the global growth decline after 2019, which was made worse by the 2020 pandemic, pushed ARLP shares below $4.
Currently, shares are trading close to $20.
The good news is that, including dividends, investors who bought ten years ago would have made a 25% profit, as the total return chart below shows.
This is what the company's dividend (distribution) looks like:
Despite lower benchmark coal prices, ARLP is currently distributing $0.70 per unit per quarter, which translates to a yield of 15%. The distribution is 40% higher compared to prior-year levels.
It also has a healthy balance sheet and enough free cash flow to protect this yield - at least under current circumstances.
The company generated $123.7 million of free cash flow during 3Q23, contributing to a total liquidity of $629.5 million at the end of the quarter.
The leverage ratios were reported at 0.36 and 0.17x for total and net leverage, respectively, which is extremely low.
It also has barely any maturing debt before 2025.
With that in mind, the company is doing well despite a challenging economic environment.
Total revenues for 3Q23 slightly increased to $636.5 million, compared to $632.5 million in 3Q22.
The rise was driven by higher transportation and other revenues, partially offset by lower oil and gas royalties. Coal sales price per ton increased by 8.3% to $64.94 per ton.
In the royalty segment, total revenues were $53.1 million, down 9% year-over-year but up 6.2% sequentially. The results reflect lower realized oil and gas commodity pricing, offset by record oil and gas volumes and increases in coal royalty revenue per ton.
Coal production decreased by 7% to 8.4 million tons, with sales volumes declining by 7.9% to 8.5 million tons compared to 3Q22.
Appalachia coal sales volumes were down 15.2% sequentially due to various factors, including lock outages and maintenance.
As a result, net income for 3Q23 was $153.7 million, reflecting an 8.4% decrease compared to the prior-year quarter. EBITDA for the quarter was $227.6 million, down 10.3% year-over-year.
Nonetheless, the distribution is safe!
Using the data in the chart below, in the first three quarters (nine months) of this year, ARLP generated roughly $520 million in distributable cash flow.
That number is the result of $748 million in EBITDA minus interest expenses, tax expenses, and maintenance capital to support the business.
The company distributed $274 million to shareholders, which means it has a 15% dividend yield with a 1.91x coverage ratio!
In the third quarter, the coverage ratio was 1.75x. Last year, that number was 3.6x.
The company targets a 2.0x to 2.5x long-term coverage ratio.
Valuation-wise, I believe that the company is trading at a good valuation, although it depends on the price of coal.
It has a well-covered 15% yield in a challenging economic environment.
If I'm right and coal prices remain high with support from higher natural gas prices down the road, I believe that the company could distribute a yield north of 20% to 25%.
However, this is not an income stock for conservative investors.
As enticing as the yield may be, investors need to be fully aware of the cyclical risks that come with investing in coal equities.
While I am starting to love this company, I would not make it a big part of my portfolio if I were an income-oriented investor.
Nonetheless, I really like this stock as an investment during potential stock market weakness, especially if the economy were to take a bigger hit in 2024.
For further details see:
Dirty Coal, Clean Cash - Earn 15% Yield From Alliance Resource Partners