Pipeline Giant Signals It's Time To Buy Coal

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

Kinder Morgan Energy Partners (NYSE: KMP) is making a move into owning resource properties with the intent of leasing them to third parties to mine. The main focus appears to be coal. If Kinder sees value in coal, it might be time for investors to buy in, too.

Pipelines

Kinder Morgan is a giant in the mid-stream oil and gas business. It owns the terminals and pipelines that get such products from where they come out of the ground to where they can be sold. It's a great toll-taker business model that provides relatively stable revenues.

With some 46,000 miles of pipelines and around 180 terminals, the company clearly has a size benefit. However, it also a growth issue. It is much harder to grow a company that's already large than build one that's small. Moreover, the mid-stream sector is no longer as cheap as it once was.

Seeing Some Value

Kinder Morgan's plans to build a business that owns and leases out coal mines is a new line of business that it can grow quickly from a small base. It already has $450 million worth of coal terminal expansions under way, so it clearly likes the industry. Buying the actual coal mines, however, is a bit out of line with its mid-stream focus.

That said, using the leasing model, like Natural Resource Partners (NYSE: NRP), removes the operating risk from the equation. Thus, Kinder will be just a toll taker, which is right in line with its strengths. And the lease model has worked well for Natural Resource Partners, even through the current downturn in the coal market.

Although 2012 was a particularly difficult year in the industry, Natural Resource Partners' top line was essentially flat. It was even able to increase its dividend. The shares yield nearly 10%, which should be of keen interest to income investors, though it's worth noting that the payout has been static for the last six quarters.

With Kinder looking to start up a business that does exactly what Natural Resource Partners already does, this is one limited partnership that investors should key in on now.

No Love

Coal's problems come from two different areas. First, it is considered a dirty fuel source, which is why environmentalists and the government have been working to limit its use. Second, and more importantly, natural gas prices have hit historic lows. That's made gas a viable alternative to coal as a fuel source for key electric utility customers. As demand for gas has increased, demand and prices for coal have fallen.

That said, there are positive signs in the industry. For example, Arch Coal recently noted that there are plans to build over 500 gigawatts of coal-fired energy capacity around the world by 2018. That much capacity will require an addition 1.5 billion tonnes of coal. And, based on current industry trends, coal stockpiles at U.S. electric plants should be at normal levels by the end of 2013. So there's a reason to believe that both near-term and long-term demand will improve.

Opportunistic

Kinder has an impressive history of success. Although the top and bottom lines tend to be volatile because it is a limited partnership, its dividend, which has increased each year for the last decade, tells the true tale of consistency that underlies its business. With a yield of around 6% after a recent industry-wide sell off, now would be a good time for investors to consider a purchase.

And that has nothing to do with the coal venture. That said, its size and financial strength make the move into coal a relatively safe way for investors interested in the space to get involved. More aggressive types might want to consider Natural Resource Partners, which shares the leasing model.

A Coal Survivor

Alliance Resource Partners (NASDAQ: ARLP) might be a more appropriate option for investors interested in a focused coal offering that are put off by Natural Resource Partners high yield. Although Alliance both owns and operates its mines, taking on notable safety and regulatory risks, it has an impressive performance history.

In fact, the company reported record results in 2012 because it was able to grow its production enough to offset the weak pricing environment. It expects to post record results in 2013, too. What makes Alliance so interesting, however, is that it continues to invest in its business. When coal prices recover, the partnership's results will get a double boost.

Alliance's impressive results haven't gone unnoticed by the market. It recently yielded around 6.3%. That's still a notable yield from one of the industry's top performers. Moreover, the company has continued to increase its dividend through coal's malaise. Those seeking a direct coal play would do well to look here.

A Sign

Kinder Morgan Energy Partners' move into coal is a sign that investors shouldn't ignore. While the most conservative should rest comfortably knowing that Kinder is making an opportunistic move on their behalf, more aggressive types should consider direct plays like coal lease company Natural Resource Partners and top-notch coal miner Alliance Resource Partners.

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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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