Alliance Resource Partners, Safe 7% yield, 44% Upside
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Alliance Resource Partners, (NASDAQ: ARLP) is an MLP coal producer with operations in the Illinois Basin ("ILB") and Northern Appalachia ("NAPP"). Coal producers have been slaughtered, down on average 67%(!) from their respective highs in 2011. Foolish contributor Chad Henage wrote a thoughtful piece on August 6th explaining why he switched from Peabody Energy, (NYSE: BTU) to ARLP. That was a wise choice. I think Peabody's earnings will be a mess next year as they move from contract mining to company-owned operations in Australia, and its acquisition of Macarthur coal has been a bust so far. With respect to ARLP, I take the analysis one step further. I recommend that investors own ARLP over any other coal stock.
Most energy or coal related MLPs own infrastructure assets like pipelines, processing facilities, rail load outs and rolling stock. And, like Natural Resource Partners (NYSE: NRP), they lease mineral resources or property containing mineral resources. I like NRP for its safer than understood distribution yield of 11.2%. I'm on record as saying that NRP will not cut its distribution this year or next. For the most part, these MLPs do not mine coal or produce oil and gas themselves. Therefore, Alliance is an anomaly that is perhaps misunderstood and under-appreciated.
Alliance gets much of the flack and disrespect of being a coal producer, but not enough credit for being an MLP. Let me explain. MLPs are frequently valued based on the distribution yield of the unit. Moreover, the stability and expected growth rate of the distribution are closely studied. In ARLP's case, distribution growth has been off the charts with an 8-yr CAGR through 2011 of about 16.6%. Even through the 2008-09 financial meltdown ARLP raised its distribution by 15% in 2008 and 16% in 2009. The latest quarterly distribution is 15.2% higher than a year ago.
Fast forward to 2012: The coal markets are in total disarray. Coal prices are down substantially and producers are cutting production like crazy to balance supply and demand. Lower production means higher per ton costs as expenses are spread over fewer tons. As a coal producer, the market assumes that Alliance is, or will be, suffering the same problems as peers. However, the Company's recent earnings demonstrate the opposite. Operations are doing quite well, thank you. Coal production is up, costs are flat and the visibility of future earnings is strong.
How is this even possible? Alliance has made excellent operational decisions over the years. It picked the two best positioned, low-cost coal basins in the U.S, the Illinois Basin and Northern Appalachia. Both basins are poised to gain market share from struggling southern and central Appalachian ("CAPP") coal mines.
Thermal coal in CAPP is especially bad right now. Unit cost inflation is difficult to contain on lower production, regulatory headwinds are greater than in the ILB and margins are getting painfully squeezed. As a very mature basin, CAPP producers are also saddled with greater legacy liabilities than ILB producers. Legacy liabilities were a main factor in the chapter 11 filing by Patriot Coal.
Here's where Foolish investors should pay increased attention, as ARLP's attractive total return upside potential is revealed. What are the chances that the stocks of Alpha Natural Resources (NYSE: ANR) or Arch Coal (NYSE: ACI) will rebound to prior highs of $67 and $36 in the next few years? Virtually zero. Each took on large amounts of debt to make transformational acquisitions at the top of the market and each is now paying the price. With significantly increased debt burdens and associated interest expense, these companies are simply not the same.
Alliance on the other hand could reasonably attain last year's high in as little as 12 months. Why? Because unlike peers Arch and ANR, Alliance is a different animal now too, but in a distinctly positive way. When Alliance hit its high of $83.25 per unit back in March, 2011, its yield was about 4.2% on an annualized distribution of $3.44 per unit. Today the yield is about 7.0% on an annualized distribution of $4.25 per unit. If ARLP's yield were to return to 5.6%, half way back to its low in March, 2011, the unit price would be $75.2.
But wait, it gets better. Next year, ARLP's annualized distribution will be higher, perhaps a lot higher. Judging from the company's distribution history, it's entirely reasonable to assume that the distribution will be 10% higher at $4.675 per unit. Therefore, at a 5.6% yield the unit price would be $83.5, a new high! The total return from today's price of about $61 per unit would be 44%. That would be a spectacular return for a coal stock with relatively low risk vs. peers.
MockingJay2011 owns shares of Alpha Natural Resources, Alliance Resource Partners, L.P., and Natural Resource Partners LP. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.