High Yield and Growth in a Downtrodden Industry

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If there’s a better value in a less well-liked industry I haven’t found it yet. I’ve written multiple times in the past about Alliance Resource Partners (NASDAQ: ARLP), and I’m back again to pound the table for this amazing company in an industry that seemingly no one wants to invest in.

Simple Economics
When it comes right down to it, simple economic factors drive the prices of commodities. Something that anyone can learn in Economics 101 is the law of supply and demand. What’s ironic is the stock market seems to have completely forgotten this simple relationship.

Some analysts, when natural gas prices were declining, were actually suggesting that this relationship would stick around forever and that coal would become a forgotten resource. The problem is, as prices decline producers have less incentive to increase production beyond a certain point. The same thing happens in the coal industry, where as demand declines coal producers cut production in response to this lower demand. It’s really simple economics, and yet Wall Street seems to forget the simple lessons.

What should be no surprise to anyone is that natural gas prices have increased from their lows, stockpiles of coal have declined, and the relationship between coal and natural gas prices is beginning to normalize. This change favors companies that have been beaten down in the coal industry, but if investors want the best investment, Alliance Resource Partners is the way to go.

The Best in 3 Different Ways
If you’re looking to invest in a downtrodden industry, it certainly doesn’t hurt to buy the company that pays you the highest yield while you wait for the industry to turn around. Alliance Resource Partners' current yield is just about 6.2%, which easily trumps the payouts from competitors like Peabody Energy (NYSE: BTU), Arch Coal (NYSE: ACI), or CONSOL (NYSE: CNX). At least, CONSOL pays about 1.74%, and at best Arch Coal pays a yield of roughly 3%, with Peabody Energy falling right in between with a yield of about 2%. The investment thesis here is very simple: when one company pays more than double the yield of its competition, you buy that company.

Even more important than a good yield, is a sustainable yield. Alliance Resource offers investors this as well, as the company generated almost $130 million in free cash flow last quarter compared to roughly $70 million in distributions. This 53.87% payout ratio is significantly better than all of its peers. For example, Peabody Energy had a 210% payout ratio last quarter, and both Arch Coal and CONSOL generated negative free cash flow.

In addition, Alliance Resource appears to have either pricing power, better efficiency, or both, as the company’s operating margin is better than its peers as well. Last quarter, the company’s operating margin came in at 20.49%. This performance was light-years ahead of its closest competitors as Peabody Energy and CONSOL reported operating margins of between 4% and 5%. Unfortunately for Arch Coal investors, the company reported a negative operating margin in three of the last four quarters.

Contractually Obligated To Grow
As if Alliance Resource could be asked to do more than we’ve already seen for investors, consider that last quarter revenues and diluted earnings per share both increased by more than 20%. In addition, the company carries a rare distinction of increasing its quarterly distribution on a sequential basis for now 20 straight quarters.

What’s even more amazing is the fact that the company contracts production multiple years out and can tell investors with reasonable certainty the level of sales for each of these years. This contractual base of sales gives investors some assurance that the company’s growth will be realized. Considering that two of their three competitors are expected to grow earnings by less than 5% in the next few years, Alliance Resource's better than 11% expected earnings growth rate looks pretty impressive.

In fact, only CONSOL is expected to grow earnings faster, and this is primarily due to the fact that the company operates in both the coal and natural gas industries. Since Alliance Resource can tell investors that 2013 production should come in between 38.1 and 39.1 million tons, and in 2014 production is already contracted at 31.6 million tons, you can see the company offers a level of certainty that is rare in the stock market.

I’ve said it before, and I’ll say it again, Alliance Resource may be one of the better values in the market today. Shares are changing hands for around 11 times earnings, and for this relatively cheap valuation investors can expect better than 11% earnings growth to go along with their better than 6% distribution rate. I’m convinced that the only reason Alliance Resource doesn’t sell for a higher valuation is because the company is tied to the coal industry. Long-term investors are being offered a tremendous opportunity, and it’s very likely in just a few weeks this distribution will be increased for the 21st straight quarter.


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Chad Henage owns shares of Alliance Resource Partners, L.P.. The Motley Fool recommends Alliance Resource Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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