Income Plays in Coal

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

The coal industry has been hammered by low natural gas prices. However, 2013 is likely to be the year in which the industry starts to turn if early trends continue. Income investors should take a look at coal focused Alliance Resource Partners (NASDAQ: ARLP), Natural Resource Partners (NYSE: NRP), and Rhino Resource Partners (NYSE: RNO).

A changed market

Low gas prices led to a decline in coal demand and prices. However, gas prices have headed higher lately. That's changing things in a big way. For example, according to U.S. coal giant Peabody Energy, power generated by natural gas was down nearly 15% through April, while coal generated power was up by 11%.

That said, coal shipments declined 7%. While that sounds bad, it actually has a very bright silver lining because inventories at power plants were down 25%. Excessive inventories have been hindering demand. Arch Coal, another large coal player, expects coal stockpiles to be at normal levels by the end of 2013 if current trends continue. That means an uptick in demand is likely.

Long-term positives

There are also long-term positives. For example, Arch highlights that there are plans to build over 500 gigawatts of coal fired energy capacity around the world by 2018. It would require an addition 1.5 billion tonnes of coal to power those plants. Moreover, the company highlights that the U.S. coal power fleet is running 25% below the level seen just five years ago. Even if there are U.S. coal plant closures, increased utilization could easily offset the drop in demand from the closures.

While Arch and Peabody are good companies in the coal space, neither offers a notable dividend yield. Income investors should favor limited partnerships (LPs) in this space. Here are a few:

The best operator

Alliance Resource is among the best companies in the coal space. It is the largest limited partnership dedicated to mining coal. And, despite the weak coal backdrop, Alliance posted record revenue in 2012 and expects to repeat the feat in 2013. Volume growth is the reason.

There are two takeaways from this. First, the company is easily handling one of the most difficult periods for coal in recent memory. Second, it continues to invest in its business and hasn't pulled back on growth. That means that it will be a stronger company when coal demand and prices recover.

Alliance has increased its dividend on a regular basis for years, and right through the current industry difficulty. With a recent yield of around 6.30%, it isn't the highest yielding LP dedicated to coal, but it is probably the safest option.

No mining here

Natural Resource Partners is an interesting play on coal because it doesn't actually mine coal. It owns coal properties that it leases out to miners. That removes many of the biggest risks of coal mining, including mine safety and environmental regulation. While the LP's results are still subject to the performance of the mines, its unique business model is worth examining.

The top line was essentially flat year over year in 2012 and bottom line results were solid. The distribution was higher, too, though it hasn't been increased in six quarters. Still, with a yield of nearly 10%, this is a good option for income seekers.

Of note is the company broadening portfolio. Although coal is the driving force, management has been moving the company into other “natural resources,” including natural gas, for years. So, the company is slowly becoming a much broader resources play. Like Alliance, management continues to invest in the business despite the difficult coal environment.

More risky

Rhino is the highest yielding option here, with a yield of around 12.80%. It owns and operates coal properties, has a coal leasing business, and is starting to venture into natural gas, too. That said, the company has been pulling back on its production and cut its distribution.

These are mixed blessings. The company has been unwilling to enter into unprofitable coal sales just to keep plants running. That shows an important level of discipline. The dividend cut, meanwhile, shows fiscal prudence, despite the bad taste that it can leave.

The cut was relatively small, though, and was accompanied by the LP's general partner (GP) cutting out its distributions. That can be taken as a sign of weakness or as a highly supportive gesture from a committed GP. Since Rhino is building out a new mine, investing in the future of its business, I see the GP's actions as a positive.

This is the riskiest of the trio, but also the highest yielding. It's a decent option for more aggressive types.

Fear

Lots of people talk about investing where others are afraid to tread. Coal is just such a place, even though there are solid long-term reasons to like the fuel source. Income investors should first look at Alliance, then consider riskier fare like Natural Resource Partners and Rhino.

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Reuben Brewer has a position in Natural Resource Partners. 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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