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Alliance Resource Partners, L.P. (NASDAQ:ARLP)

2013 Wells Fargo Securities Research and Economics 12th Annual Pipeline, MLP and Energy Symposium Conference

December 10, 2013, 3:55 PM ET

Executives

Brian Cantrell - Senior Vice President and Chief Financial Officer

Analysts

Sam Dubinsky - Wells Fargo Securities

Sam Dubinsky - Wells Fargo Securities

Hi, everyone. My name is Sam Dubinsky. I cover the coal MLP space for Wells Fargo. It is my pleasure to introduce Brian Cantrell, the CFO of Alliance Resource Partners. Brian will be giving a presentation. If there is time left, we'll be doing some Q&A here. And then we'll follow it up with a breakout session in the Louis east room. Thank you, Brian.

Brian Cantrell

Thank you, Sam. And first, we want to thank Sam and his team and everybody at Wells Fargo, this turned into just a tremendous conference and it's always a pleasure to be here. The slide deck, here we go. We're getting the technical issues worked out here.

Let me start today with just a brief overview of our companies. We do have both our LP and our GP that are publicly traded. Starting over on the left-hand side of the chart with our limited partnership, trading under ARLP. We've been public since 1999. We were the first and remain the largest MLP focused on coal production and marketing.

We've recently been trading in the mid-70s, year-to-date unit price increase is around 30%. I think we've been up since this slide was prepared at the end of last week. At our current annualized distribution of $4.70, we are yielding about 6.2%.

Next slide, you can see, we have a very conservative balance sheet. Our current debt-to-EBITDA is about 1.14x. Lot's of capacity available to us, should opportunities to transact, present themselves. I think at the end of the third quarter our total liquidity was about $595 million. So we have plenty of availability under our existing revolvers and strong cash flows that allow us to execute on our plans.

Our GP is also publicly traded. The only asset it owns are the typical roughly 2% GP ownership in the limited partnership. It owns a 100% of the IDRs, which have been in the high splits for sometime. And in our case, we also own 15.5 million common units or roughly 42%.

This map shows where our operations are focused. On the left-hand side, in the blue circle, you can see that we are predominantly in the Illinois Basin, and I'll get into the strategic reasons, why we are located there, here in a moment. But many of our operations are located there. That's by far our largest area. We are the largest producer in that region at this point in time.

Moving into the east, we do continue to have a small presence in Central Appalachia with our east Kentucky operation. And up northeast of that, in the Northern Appalachia region, we are also participating in that market. And with the opening of our Tunnel Ridge mine and the continued ramp up production from that operation, we are growing in that region as well.

This chart show some of the results that we have enjoyed over the last few years. You can see we've had a continuous record of growth in 2012. We had our 12 consecutive year of record results, every year since we've been public. And the little blue bars on the each of those lines shows what our current guidance ranges are for 2013. So we're well on our way toward having our 13 consecutive year record growth.

That's allowed us to show nice increases in our distributions. At the limited partner level, we've been able to increase distributions for 22 consecutive quarters. We've recently been growing our distribution to the LP unitholders at about 2% per quarter, given the IDR leverage at the GP that equates to roughly a 3% growth rate per quarter at the GP.

And consequently, well, I'm sure you're all aware of some of the very negative headlines in the coal space generally. Our performance has been well above the coal index, which is the purple line on this chart, also well outpacing the S&P 500.

For the limited partnership, since we've been public 10 years, we're in the S&P analysis of compounded annual growth rates over a 10-year cycle. Since our 10-year anniversary as a public company, we intended to rank in the upper one-half of 1% to upper 2% or thereabout.

I think in the most recent ranking that came out in November of this year, compounded annual growth rates at our limited partnership over the last 10 years have been roughly 29%. So our unitholders that have been with us for a while have been well rewarded.

So let's talk about the markets a little bit in more detail. As I mentioned earlier that all you did was read the headlines around coal, you'd wonder how the industry is surviving at all. And while those headlines are clearly, there is tremendous pressure on the industry coming from natural gas competition, coming from the regulatory environment, there continues to be opportunities.

Our thesis is, is that of the three primary sources of base-load power generation, coal, natural gas and nuclear, coal and natural gas will continue to dominate that market for the foreseeable future. And what we do expect to see is that while those two fuel sources will makeup roughly two-thirds plus or minus power generation in the U.S., we do anticipate that market share between coal and natural gas will let them flow as commodity prices move around. We've seen that over the last two years.

In 2012, when natural gas pricing got down into the $2 MMBtu range, you saw a significant switching from coal to natural gas. With the current natural gas curve, which I think is right here, the little bar, the shaded area shows the price point at which Illinois Basin and Northern Appalachian coal compete and actually win on the economic dispatch curve relative to natural gas.

So this year, you've seen a significant movement back toward coal away from natural gas. We expect that dynamic to continue to play out for the foreseeable future. Still continuing to dominate overall power generation that market share may move up and down as commodity prices fluctuate.

In the end, we think that in the U.S. market, in particular, coal will be relatively stable in terms of total demand. So an obvious question to an investor is, if you're telling me you're essentially in a no growth industry, where are the opportunities for growth for our company. That talk requires you to really die below the headlines, looking beyond at overall flat demand environment and take a look at where peoples' assets are positioned. So even in a generally flat U.S. domestic market overall, there are still opportunities within the various regions, as dynamics and fluctuations between the various regions continue to play out.

What we have seen is evidenced in the chart on the left-hand side of this page is that Central Appalachian coal has been under significant pressure for quite some time. And you're seeing the volumes that are coming out of that region fall-off precipitously. Obviously, what that does in an overall steady demand state, if one of the components is falling out of favor and production is declining that creates opportunity for other regions to capture market share.

And the reason is fairly straightforward. The chart on the right is showing what the average cash cost are for production in Northern Appalachian, Illinois Basin and Central Appalachian. The red line on the upper part of that chart is showing what Central Appalachian cost had done. That area has been mined for a 100 years. Lower cost reserves have already been depleted, just the general cost structure. The regulatory scrutiny that they're faced with, limitations on transportation options, et cetera, just put them at a much higher cost curve relative to Illinois Basin and Northern App.

So what we expect to find is that, as Central App continues to decline, Northern App will take some of that market share, Powder River Basin may be able to take some of that market share, but the bulk of the growth is going to come in the Illinois Basin. In fact, I think the Illinois Basin, if I remember the stats correctly, is the only region that in the last few years has shown not only increased production, but also increased demand. And we believe that our Illinois Basin assets in particular are very well situated.

We've been getting questions recently around how can we capture pricing that appears to be well above what market clearing is today in this region. You may see a spot transaction for the Illinois Basin, quoted that's in the low-40s, call it. Our price realizations in the second or in the third quarter of this year out of the Illinois Basin region were roughly $52 in change.

So we've got quite a spread between what the apparent market clearing price for production in the region is and what we're actually realizing. There are several factors around that. As you know for most thermal producers, you can track down over a long period of time.

So we have legacy contracts in place that were reflective of price at the point in time and those were entered into, and frankly for some of those also have a higher price tags. But the other factors that come into play is if you cannot take a single mark on a spot transaction and apply that as a uniform basis across the region, so you may see an 11,500 BTU product delivered into a river utility that's priced in the low-40s.

We provide a wide range of products available to our customers. We can go from 10,500 to 12,500 BTU. We have a variety of sulfur content. We have a track to trace elements. All of those quality differentials have a price impact. We also are very strategically located relative to our customers. We have numerous transportation options available to us. At our River View mine, we can load directly into the barge.

We have rail access on both the CSX and V&S. We can participate in the local truck markets. Those two have a price differential. By way, again as an example, using River View as a benchmark, the fact that we can load directly into the barge of that mine gives us a $5 to $6 per ton improvement over what another producer may be able to realize, if they have to rail or truck and then transload their production into a barge to get it into the same market.

And in fact what you have to do is you can't take just the single market you might see on a small contract and apply that across the board. You have to break the region down into its various components, qualities, rail market, barge market, local market, all of those things impact pricing and when you start with a benchmark and factor those quantitative impacts in, you very quickly backup to the pricing that we're realizing.

Another good benchmark is, if you compare us to the second largest producer in the region, people out here believe their price tag in the last quarter was $50 in change. So very comparable to our $52, $53 number. Those are the quantitative factors involved. We also believe that in the manner in which we contract, we're able to maximize the value of our production.

We look at the market from very top-down and bottom-up perspective. We've developed a proprietary database, where we know in detail what our customer's requirements are? Who they are currently receiving deliveries from? What coal qualities, they are able to take? We know who their suppliers are? What their cost structures look like? What their transportation options are? And we try to target our activity towards those customers that allow us to maximize the value of our production.

Our marketing team has done a remarkable job this year. It is a tough market, without question. Through the third quarter, I think we had committed, round about 9.5 million tons in new contracts this year that prices up for above our currently realizations. Since then we've committed another 1.6 million tons. So we are heading into 2014 approximately 86% pricing committed today. That puts us in good step to be able to be selective. And when we transact and at what price we're willing to transact, again continuing to maximize the value of our production.

Other qualitative factors are financial stability, more balance sheet strength. Customers know that when we enter into an agreement, we have the wherewithal to honor it and that gives them the confidence to contract at term and not just look at us as a spot player. And then our performance history, we have very long-term relationships with most significant utilities, again allowing us to contract on a long-term basis that gives us a value pickup relative to what a spot transaction might look like today.

And so if you look at our reserve base and our production, this chart looks at what we reported at the end of last year. Roughly 82% of our reserves are located in Illinois Basin, 13% in Northern App and the balance in the Central Appalachia.

I am sorry, I was talking about production. Reserves are 80%, 18% and 2%. With the impact of Tunnel Ridge increasing production next year, you'll see our production levels and the reserve levels in a much more similar position. So we have purposely focused our efforts in the Illinois Basin where we see growth, and in Northern Appalachia where we see a steady market, and an ability to participate in that areas to allow our customers to have some diversity in their supply.

Now, let's talk about the future. Our bread and butter historically has been focused on organic growth. What we have done very well over the years is identify the next generation of reserves, bring it to the market when the market tells us the demand is there. So we don't feel bounce back, and we're able to contract at very high levels to support and justify the capital commitment.

We have one mine that's coming online third quarter of this year at our Gibson South operation. We will likely start that as a three unit operation initially and ramp to four and then five units ultimately. Once we get to five units of production we should be at an annual run rate of about 5.1 million tons a year.

We are also participating in the White Oak project. This is a little bit of a different approach to what we typically do where we own, control and operate all of the operation. In this case, there was a group that put together a nice reserve base. They were looking to bring production into marketplace. They needed a partner that had industry experience, and when we chose to transact in a way that we believe gives us the opportunity for an attractive return, and while we don't control the activity, as a significant owner we do have influence.

We structured in a way, where we have three different cash flow streams from the project. We have acquired and are leasing back to the mine operator all of the reserves. So we'll get a royalty stream once production occurs. We did construct, own and will operate all of the surface facilities. So the coal handling preparation plant et cetera is ours. And as production comes out of the mine and touches our facilities, we'll get a throughput fee. So that's a second stream.

And then finally, we took an equity position and the operation that in effect gives us all of the residual cash flow from the mine, until we're able to achieve a preferred return. So that operation, the Longwall is under construction. It will start up some time in the second half of the year. And we should begin to see meaningful cash flows out of that operation in the 2016 timeframe.

And so what you see is we still have a very visible pipeline of growth in front of us just from the projects that we've announced thus far. We have other reserves that are in our portfolio. Again, when the market tells us the demand is there, we can begin to execute on those activities and continue to grow our production.

If you look back over time, our growth and distributions is correlated very closely to what our growth and production is. What you see here that we have a nice runway for future growth over the next several years. And then hopefully as the market continues develop, we can follow our tried and true method of bringing on the next generation reserves at the appropriate time.

So why Alliance? I'm not going to read all of these points to you, but we know who we are, we know what we do well and we execute very effectively. We've been purposeful in putting ourselves into basins where we continue to see growth opportunities, even in an overall environment that remains very challenged. We're fortunate that we're on the low-end of the cost curve in those regions, which gives us market power.

As I've mentioned, we are highly contracted. We do expect to see a slight price pickup overall next year compared to what our 2013 realizations are. Some of that will be mix as Northern Appalachian production increases relative to the other regions. You would expect to see a higher increase in pricing, but as we look at the Illinois Basin, we also expect to see comparable, if not slightly higher prices next year as well.

Our balance sheet, our performance history, look, I would stack up nearly 30% compound at 10-year annual return with anybody. So we think we have had a remarkable track record. And we have continued opportunities in front of us, and hope you all are interested and willing to come along for the ride with us.

With that, I appreciate it and we'll take questions. Sam?

Question-and-Answer Session

Sam Dubinsky - Wells Fargo Securities

Thanks for your great presentation. Could you just comment on the state of coal inventories? And at what point do you think utilities will start to restock because it looks like inventories are starting to bleed lower than they have been historically?

Brian Cantrell

You've seen the recent reports that show coal inventories coming down fairly significantly, much more in line with historical levels, whether you're looking at aggregate or on a burn day basis. You do have to again look at the various regions, the Central App and Northern App. Those stockpiles have declined faster than the Illinois Basin.

I think as a general statement, utilities are changing their buying pattern somewhat. I think if you talk to utility execs, they want to have diversity and flexibility. So give them a portfolio generating options that allow them to make rational economic decisions as commodity prices, fuel prices put prices move around, so they can deliver low cost power to their customers.

They are trying to figure out what this market is going to look like both on the coal and gas side as well. So I think you're seeing short tenure on new contracts moving from maybe five, six, seven year duration to three durations. I believe utilities currently are somewhat less committed coming into a year than they have been historically. Again, just willing to take a little bit of risk for the spot market, sort of gas prices move one way to the other they can adjust on the coal side.

Sam Dubinsky - Wells Fargo Securities

And then your coverage ratios are very high, and it appears that for you guys at least, thermal coal fundamentals are slightly better. At what point do you think about increasing the rate of your distribution? What are the metrics we should look at when you evaluate that?

Brian Cantrell

That's fair. I mean what our objective is on distribution, is generally to try to show growth that's on the top cortile of the MLP space. We're not trying to drive it to a particular distribution coverage level. We recognize our business is somewhat lumpy to put in a new mine as a two to three year process, $200 million to $400 million in capital, where a lot of cash is going out the door and you're getting no cash flow coming back until product starts. So at times you've seen our coverage levels in the 2.2x to 2.3x level. Today it's, I think about 1.6x or 1.5x thereabout. So we're happy to let it ebb and flow. And again, as long as we can try to keep pushing our overall growth at the upper cortile, that's what we'll be happy with.

Sam Dubinsky - Wells Fargo Securities

And just my last question is on the M&A front, you have allowed your own organic projects, so how do you, after those are done, do you about think about more M&A in the coal space, because you allow that stuff for sale or you evaluate ever sort of looking outside of coal through next like?

Brian Cantrell

Well, talking about the coal space first, yes, there are assets for sale. You have seen some transactions that have occurred recently. Look, with our balance sheet, we're one of the few companies that really has the capacity to be able to transact, if it makes sense to us in many cases, so we are on everybody's list. We're very well aware of all of the assets that are available. We're very disappointed in how we approach that, the asset and the operation has to make sense to us.

We're concerned not only about profitability, but customers. Does it help us support our existing customers? Does it help us possibly to expand our market reach? We pay attention to, is it a union operation or a non-union operation? All of our operations are union-free. So all of those factors come into play as we assess whether we're going to transact or not.

Again our bread and butter has been organic. We have transacted in the past and we would absolutely transact in the future, if it make sense, but we're continuously looking at what our alternatives are. If we feel like we can deploy cash organically and get a better rate of return we will do that. If M&A opportunity presents itself, and it's either immediately accretive, or strategic, or in some cases even defensive, we would absolutely look to transact under the right circumstances.

Outside of coal, we do evaluate that periodically. I would say our view at the moment is we continue to have opportunities in front of us within our course base for the foreseeable future that we believe will allow us to capture higher returns than we might be able to achieve if we tried to enter into an M&A transaction in the mid-stream market, by way of example. When you're seeing 10 or 12 times multiples being paid today, we think we can get more return for our unitholders by staying within our core.

Any other questions? Yes, sir.

Unidentified Analyst

Are you unionized?

Brian Cantrell

The question is are we unionized? No, sir, all of our operations are union-free.

Unidentified Analyst

[indiscernible].

Brian Cantrell

Our current coverage ratio is about 1.5x, 1.6x. Any other questions? Really appreciate everybody's time. Thank you very much.

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