The Gift That Keeps on Giving

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Alliance Resource Partners Poised to Outperform in 2013

A few weeks ago I profiled Natural Resource Partners, (NYSE: NRP), a 12%+ yielding Master Limited Partnership, "MLP." See post here. As we enter 2013, I'm back to discuss coal producing MLP, Alliance Resource Partners, (NASDAQ: ARLP). The units of both of these companies have been battered since early November due largely to Obama's reelection and fiscal cliff fears. In an article from early December I argued that the significant sell-off in MLPs is unwarranted, see post here.

After suffering through a terrible November, in December some coal stocks such as Alpha Natural Resources, (NYSE: ANR), and Walter Energy, (NYSE: WLT) bounced back strongly, up 30% and 19%, respectively. Meanwhile, the units of NRP and Alliance were flat and down 2%, respectively. Despite having substantially lower stock market betas, these two MLPs are vastly under-performing. Market sentiment on coal stocks has improved, but the unit prices of NRP and Alliance have not yet responded.      

Focusing on Alliance, it's highly unusual for Alliance to meaningfully under-perform peer coal producers to the extent that it has. Therefore, there's a good chance that this performance is related to fears of the fiscal cliff. However, several weeks ago I pointed out that MLPs should not sell off as much as high yielding common stocks. Quoting form this article, quote,

"The contemplated changes in the tax code, the big bad wolf, the fiscal cliff....WOULD NOT negatively impact MLP distributions because MLP distributions are already taxed as ordinary income! To reiterate, tax on qualified common stock dividends could rise from 15% to 35%-39%, but MLP distributions are already taxed at the higher rate, albeit on a tax deferred basis." 

Alliance Has The Best Balance Sheet and Operating Metrics

Unless Alliance's operating results or balance sheet are getting worse, there's no good reason for the sell-off in this company's units. Alliance is best in class. Alliance is trading at just a 4.8x ratio of its 2013 expected Enterprise Value, [Market Cap + gross debt - cash], "EV", to Earnings Before Interest, Taxes, Depreciation and Amortization, "EBITDA."  This is a cheap valuation compared to Alpha at about 9x and Walter at about 7x. 

Alliance is expected to have an EBITDA margin of 28% in 2013 compared to peers expecting to average about 18%. Alliance has a net debt to 2013 expected EBITDA ratio of ~1.4x compared to peers with ratios of 4x-8x. These metrics speak volumes. Alliance offers a spectacular yield (about 7.5%) and a rapidly growing distribution, (nine-year average distribution growth of 15%).

Given the poor performance, one might presume that Alliance has slow production growth, but that's not the case. In addition to a stellar balance sheet and superior margins, Alliance also has the strongest 3 year organic growth profile in the industry. While peers are cutting production, Alliance is increasing production. How could this be? Alliance's business strategy has always been to heavily contract both volumes and prices forward for at least two years. This decade-long strategy enables Alliance to grow even in a weak market because they are 95% booked for 2013.   

Go With The Best in Class in 2013

Not long ago, Peabody Energy, (NYSE: BTU) was the class act of the coal space. Today that title absolutely belongs to Alliance. Peabody is still a solid company, but last year's poorly timed acquisition of Australian producer Macarthur Coal is weighing heavily. Peabody materially overpaid for Macarthur and it's uncertain if the margins on that company's coking and PCI coal operations will ever return to 2011 levels. Aside from Macarthur, Peabody's move into Australia several years ago is not looking so hot these days. Australian miners have experienced tremendous increases in production costs over the past 5-6 years.

I believe that Alliance units are a bargain under $60. With a 7.5% yield and a growing distribution, the total return potential for 2013 is significant. In early 2011, Alliance units were trading in the low $80's on a much lower distribution. The yield back then was as low as 4.3%. If Alliance's units were to trade at a 6% yield a year from now, the total return would be about 32%. I believe a 6% yield is still attractive in today's environment of ultra-low interest rates.

Foolish Bottom Line

Given the under-performance to coal peers mentioned in the first paragraph, I feel strongly that Alliance will close the gap in 2013. If stocks like Alpha and Walter have a good year, Alliance will do quite well. And, if peers falter, I think there's still a good chance that Alliance will turn in a positive return for the year. I see limited downside and considerable upside for Alliance in the next 12 months.  

 


MockingJay2011 owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!


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