On The Dividend Trash Pile: Coal Companies

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

Coal and the companies that mine the mineral have taken it on the chin for several years. A large portion of that can be attributed to the increased prominence of natural gas. Gas has taken center stage in The United States because of fracking (hydraulic fracturing), a new drilling method that has made previously hard to reach gas easier to extract. This has resulted in natural gas being price competitive with coal as a base load fuel source for power generation, one of coal's two main uses. This, plus natural gas' relatively clean public image, has led utilities to use more natural gas. 

However, new rules and regulations enacted during the Obama administration have made it hard, if not impossible, to build new coal fired power plants in the United States. These rules, inspired by Obama's very public desire to push a clean energy future, have even made it hard to continue operating existing coal fired energy plants. So utilities have been forced to shutter older, less efficient plants because the cost of upgrading them to current standards is too high.

Longer term, coal definitely has some problems. However, utilities need to ensure that they have a steady flow of fuel for their power plants. Using just one fuel source would be a massive risk and one that very few management teams would be willing to take. As such, even though utilities are switching to gas plants, coal will likely remain an important source for decades, a fact that will remain true if for no other reason than fuel source diversity.

If natural gas prices should rise, however, coal would likely find itself in demand again based on price. In its last quarterly earnings report, Industry giant Peabody Energy (NYSE: BTU) hinted that it was seeing what it believed was the beginning of just such a turn in demand. This was an almost inevitable event based on the fall in the number of drilling rigs looking for natural gas, due to low gas prices, and the shuttering of coal mines due to low coal prices. Indeed, supply and demand have a way of finding equilibrium, even if the search for it is painful for a time.

While regulation remains a wild card, value investors with longer time horizons may have some incredible buying opportunities in the coal industry. This is particularly true in light of the post election sell off in coal stocks. A few to consider are: Peabody Energy, Alliance Resource Partners (NASDAQ: ARLP), CONSOL Energy (NYSE: CNX), and PVR Partners (NYSE: PVR).

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Peabody Energy is the eight hundred pound gorilla of the coal industry. It has material operations domestically and in Australia, which gives it direct access to key Asian markets. While the demand picture in the United States is expected to be less than compelling, developing economies are slated to continue building coal plants for many years to come. China and India both use large amounts of coal, but so, too, do smaller countries in the region. With material exposure to these markets, Peabody is in prime position to benefit. And, should domestic demand and pricing firm, as Peabody has suggested has begun to happen, this industry giant will benefit.

The recent sell off has brought Peabody's yield higher, but it is still a bit low for my taste, so I would recommend that more aggressive income investors consider Alliance Resource Partners. Alliance is one of the largest coal focused limited partnerships (LPs) and boasts an impressive track record of performance highlighted by regularly quarterly dividend increases since 2008. Note that those increases were made despite the difficult demand and pricing environment. Alliance's operations are based primarily in the Illinois Basin, Central Appalachia, and Northern Appalachia. Since its customers are mostly domestic, it lacks the global diversification that Peabody offers. Still, as a limited partnership, Alliance enjoys certain tax benefits that allow it to pay out a materially higher distributions to unit holders. Although global diversification is scant today, the export of coal is likely to increase over time, which would provide additional markets for Alliance to tap. The company's yield is well above the market's average, and that of Peabody, making this an enticing option for more aggressive long-term income investors.

CONSOL and PVR provide diversification in a different way, since both are using their cash cow coal businesses to fund their expansion into the natural gas space. This is an interesting twist that should allow the companies to benefit no matter what happens in the struggle between natural gas and coal. The two, however, have taken slightly different paths. CONSOL, which sports a relatively low yield, has moved into the natural gas drilling business, highlighted by the purchase of assets from Dominion Resources. This direct exposure opens the company up to the benefits and pitfalls of yet another commodity, but one that appears to have a bright future. PVR, on the other hand, is a limited partnership with a hefty yield because the market is discounting its new assets due to its legacy coal assets. But, the bright spot for this LP is that it has grown its operations in the mid-stream segment of the natural gas market and eventually the market will recognize that it is no longer as tied to coal as it once was. PVR avoid commodity price risk, however, because it simply gets paid a fee to transport the gas from one place to another. The company's purchase of Chief Gathering was the transformational event for PVR. Another interesting fact about PVR is that it doesn't actually mine coal, it just leases out its coal properties to other companies in exchange for royalty payments. This removes the many risks associated with operating a coal mine and helps make PVR a relatively low risk way to gain exposure to the industry.

I would expect the share prices of these four coal companies to rebound from the post election sell off. This is a normal market reaction. Still, dividend investors should keep an eye on all of them. The market can go to extremes over short periods of time, but Obama's longer term goals aren't likely to alter nearly as quickly. Indeed, there might be additional buying opportunities for those with a long-term focus.

Yours,

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ReubenGBrewer has no positions in the stocks mentioned above. 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.

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