This Coal MLP Reaching Bargain Levels Again
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Units of Master Limited Partnership (MLP) Alliance Resource Partners, (NASDAQ: ARLP) were a great buy in the mid $50's earlier this year. I bought some, but wish I had bought more. I may get another chance. Subsequent to my purchase, ARLP announced yet another blockbuster increase in its distribution to an annualized rate of $4.25 per unit, up 15% year-over-year in one of the worst coal markets imaginable. The unit price moved up strongly, hitting $67 on August 22nd. Today the price is back to about $60, offering a 7.1% yield.
The investment rationale is fairly straightforward: Alliance has been able to increase its distribution by close to 15% per year for the past 9 years. Going forward I think it's reasonable to assume distribution growth averaging at least 8% for the next 5 years. An 8% increase from the current annual distribution rate of $4.25 per unit would get us to $4.59. Assuming a 5.85% required yield, (the mid-point of yields over the past few years) that would equate to a unit price of $78.6 for a total return of 38%.
So far I'm just throwing out numbers. Foolish investors are no doubt asking what's behind the numbers, where's the meat of the analysis. I believe that distribution growth of 8% is a conservative assumption. Support for this assumption is not based merely on 9 years of distribution history; it follows from the fundamentals of the business. Alliance has very low debt leverage, solid organic growth in the best coal basins in the country and a meaningful cushion of distributable cash flow above what gets paid out.
The ratio of cash available for distributions to the amount actually paid out is an important measure of how safe a MLP's distribution is and how aggressively it can be raised. Even in this terrible year, Alliance expects distribution coverage of 1.4x-1.5x. This compares to roughly a 0.9x ratio for Natural Resource Partners, (NYSE: NRP). NRP does not enjoy robust distribution growth, but it has a current yield of close to 11%. NRP is riding through the coal market storm before resuming modest distribution increases. I think the 11% yield is worth the wait.
Back to ARLP, Net Debt to EBITDA is under 1.5x and expected to remain below 2x, a level that's less than half that of Arch Coal's, (NYSE: ACI). Arch faces difficult headwinds with elevated debt of $4.5 billion after acquiring International Coal last year. Heavy interest expense will make it hard for Arch to generate significant free cash flow to pay down this debt. Alliance dodged the acquisiton frenzy of 2011.
As the prospects for non-MLP coal producers like Alpha Natural Resources, (NYSE: ANR) and Walter Energy, (NYSE: WLT) have come under renewed pressure due to another leg down in coking coal prices, not a lot has changed for Alliance. Fears of slower exports in the second half 2012 will not impact ARLP either because the company does not produce much coking coal and does not yet have meaningful exports. Steady and reliable performance is what investors seek in a MLP; spectacular distribution growth is icing on the cake.
Alliance is well positioned in the Illinois Basin and growing rapidly in Northern Appalachia, the 2 best coal basins in the country. The Illinois Basin is especially strong as an emerging basin with low costs and strong export opportunities through the Gulf and the Great Lakes. Alliance is the 2nd largest producer in the area at close to 30 million tons. Key to the company's growth is low-cost expansion in Northern Appalacia, where annual production will more than triple to 8-9 million tons by 2014.
An interesting thing has happened in the past few months. By simply remaining largely unchanged, Alliance's formerly mediocre margins and valuation metrics are now at the head of the pack. For example, Walter and Arch enjoyed EBITDA margins of 30%-35% in 2011. Next year, none of the U.S. coal producers are likely to reach a margin of 25%, but Alliance's margin is forecast to be in the upper 20%'s. Earlier this year, peers were trading at a 1-yr forward EV/EBITDA multiple of 4x-5x; today that range is 6x-9x. Meanwhile, Alliance is trading at a bit under 5x next year's expected EBITDA.
Therefore, in many ways Alliance has similar upside to non-MLP peers, but with a dividend yield about 4x the peer average. Given the severe pain in the coal markets, a total return approaching 40% would be a tremendous outcome for an investment that I believe has limited downside after collecting its 7% yield.
MockingJay2011 owns shares of Alpha Natural Resources, Walter Industries, 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.
