Alliance Resource Partners, a Safe Coal Play
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Is Alliance Resource Partners a Buy After Massive Out-performance?
I've written several articles on coal Master Limited Partnership Alliance Resource Partners, LP (NASDAQ: ARLP) here on TMF and on Seekingalpha. Late last year I opined that Alliance and Natural Resource Partners, LP (NYSE: NRP)were over sold due to fiscal cliff fears. In the past 12 months, Alliance's units are is UP ~20% while the Market Vectors Coal ETF, (NYSEMKT: KOL) is DOWN close to 25%. Does this substantial out-performance mean it's time to sell Alliance or swap into another coal producer? NO!
Sometimes it makes sense to rotate out of winners into beaten down stocks that could possibly rebound smartly. There are plenty of slaughtered coal stocks to choose from. For example, Alpha Natural Resources, (NYSE: ANR) is down 45% and bellwether Peabody Energy, (NYSE: BTU) is down ~35%. Yet on a risk/reward basis Alliance is still the best bet.
Alliance Avoided the Mistakes of Others
Alpha, Peabody and others both made poor decisions in 2011 by acquiring companies at the peak of the coal cycle and failing to lock-in elevated coal prices via long-term contracts. Alpha acquired Massey Energy and Peabody acquired MacArthur Coal. Both assets have been written down significantly. Even if coal prices spike again, Alpha and Peabody will never get that value back because the written down assets were closed for good.
Alliance's 6.7% distribution yield towers above peer coal producers, none of which have a yield even close to 3%. I believe high yielding investments will continue to be sought after with ten-year treasuries yielding just 2% and stock market indices at all-time highs. Alliance has greatly outperformed other coal producers, but is far from an all-time high itself. Two years ago Alliance traded as high as $82, 24% above today's unit price of $66.
Alliance's 2011 High of $82 Equivalent to a Unit Price of $96 Today!
That's right, two years ago when the unit price reached $82, the annualized distribution yield was roughly 4.5% on a distribution of $3.56 per unit. Today's $4.43 annualized distribution on the unit price of $66 equals a 6.7% yield. If the yield required for investors to own Alliance units declined to 4.5% tomorrow, the resulting unit price would be $96, 45% above the current unit price.
I point this out to suggest that unlike the broader markets, Alliance still has ample room to run. If one believes that the S&P 500 has achieved most or all of its gains for the year, an excellent risk-adjusted alternative is Alliance Resource Partners.
Alliance Distanced Itself From Performance of Peers
If Alliance were like other U.S. coal producers, they too would be in a world of pain. However, in almost every way imaginable, Alliance has avoided the pitfalls and coal market risks while maintaining strong operating results. Importantly, visibility of future strong operating results is firmly in place for 2013-2014. That's because the company is 100% contracted for 2013 and 85% contracted next year.
This contracting strategy alone accounts for a big part of Alliance's out-performance. Not to mention that the company's decision to operate in the two best regions of the U.S., the Illinois basin and Northern Appalachia. These regions have low cost structures, enabling them to remain competitive even when natural gas prices plunged well below $3 per MCF last year. Today's natural gas price above $4 per MCF offers strong support for coal prices in Alliance's regions.
Even with stock markets at record highs, some pundits believe stocks will go higher still. While possibly true, if instead markets trade flat to down in coming months, Alliance could rise as investors search for higher yielding opportunities. With many of the usual suspects, (utility, pharmaceutical and telecom stocks) at all-time highs, their respective yields have fallen. Alliance's 6.7% distribution yield is twice that of the typical high yielding common stock. I strongly believe that Alliance has a good chance of outperforming the markets over the next year, perhaps by a considerable amount.