Why Can This Coal Company Grow?

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

Alliance Holdings (NASDAQ: AHGP) outlook and recently reported earnings support taking a further look into a coal company for a change.  Alliance is a master limited partnership (MLP) and derives all its earnings and cash flow from its ownership in Alliance Resource Partners (NASDAQ: ARLP).  Alliance has steadily increased coal sales over recent years despite headwinds.  It has mines located in the right coal producing regions, allowing Alliance sales and distributions to grow in spite of negative industry trends.

Alliance Growing Despite Coal Trends

Cheap natural gas has driven power plans to use natural gas in place of coal.  In 2007, coal accounted for around 50% of power production, it now accounts for 37% of electricity generation on a rolling twelve month basis in the most recent EIA data.  This is why the increase at Alliance is impressive and worth noting.  Alliance has increased production over this time frame, in both Northern Appalachia and the Illinois Basin. 

Alliance produced 23.8MM tons and 34.8MM tons in 2007 and 2012, respectively.  Over this period, Central Appalachian production declined from 3.2MM tons to 1.9MM tons.   An increase in the Illinois Basin of 10.7MMtons and of 1.5MM tons from Northern Appalachia more than offset the decline.  Central Appalachian room & pillar mines historically have a significant higher cost per ton to mine. Longwall systems are used in Northern Appalachia and the Illinois Basin reducing the cost per ton significantly.  The use of scrubbers on coal fired power plants make the higher sulfur content from these coals somewhat irrelevant the marketplace now. 

Positive 4Q12 Results

AHGP announced earnings per unit of $0.88, above consensus of $0.81 and the distribution per unit was $2.83 for FY12 versus $2.39 the prior year.  AHGP only asset its 1.98% general partner interest, 100% of the incentive distribution rights and 15.5 million units all in ARLP.  ARLP reported earnings of $1.87 per unit beating consensus of $1.32 behind outperformance on both the top and operating line at its Illinois Basin mines.    This drove a y/y sales increase of 10.3% at ARLP.  Distributions increased by 2.1% and 2.8% at ARLP and AGHP, respectively.  

Alliance contracts their production for future delivery to stabilize cash flows.  This does hurt their ability to benefit from significant price increase in the short term but creates steady distributions for holders of AHGP.  It has contracted 38.5MM tons of 2013 production, the mid-point of the guided range of 38.1MM tons to 39.1MM tons.  In addition, almost 90% of production in both 2014 and 2015 is already on contract pricing.  

Summary

In the current weak coal market, AHGP is an interesting opportunity.  The cash flows are stable with most of their future volume accounted for.  Alliance is continuing to invest in new mines and expansions of the current ones, which should drive increases in earnings per unit and importantly distributions per unit.  That said, if coal starts to rebound, Alliance holders will not benefit in the same way holders of Peabody Energy, Alpha Natural Resources (ANR), or Arch Coal (ACI) who have less volume on contract and greater exposure to recoveries in the currently weaker geographies.  Peabody Energy has most of its operations in the US Midwest and the Powder River Basin.  Free cash flow is positive on Peabody's end but nothing like that of AHGP. 


mthiessen has no position in any stocks mentioned. 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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