The advantage of low cost competitors dominating economic returns is especially evident in the resource sector. During an industry downturn the most efficient operators take market share from high cost competitors.
With the U.S. thermal coal market depressed, investors are looking to natural gas (UNG) for clues to invest in coal. Over 100 million tones of annual coal production has been displaced by over-supplied natural gas. If natural gas production declines coal would have a strong cyclical rebound. While natural gas has yet to show a meaningful a production fall, the continued decline in the rig count may bode well for the future.
Alliance Resource Partners (ARLP) is by far the strongest coal producer. In an extremely challenging environment, Alliance has continued its long history of robust growth in coal production, cash flow and distributions. As a Master Limited Partnership in a low interest rate world, Alliance yields 7.2% and has increased the distribution for 17 consecutive quarters.
In the second quarter Alliance continued to invest in new mines while competitors scrambled shut production. Alliance anticipates 2012 capital spending of $565-610 million to continue growth. Operating primarily in the low cost Illinois basis is advantageous.
Weak competitors such as Arch Coal (ACI) may be walking dead. James River (JRCC) shares are depressed enough to have a market cap half of the company's liquidity position. Yet judging by trading volumes and market chatter speculators continue to insist on gambling in these weak, risky, levered names for a coal rebound.
Coal stock speculators demanding leverage to a potential industry rebound should consider call options on the strong companies. With current coal pricing, the high cost coal names are essentially call options with expiration before the next debt maturity. Perhaps actual call options on strong industry participates who are winning in the marketplace would be a better bet.
In this industry downturn the strong are taking from the weak. Join me as I follow the industry.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.