Alliance Resource Partners LLP, the Gift That Keeps on Giving
I've written a few articles on Alliance Resource Partners (ARLP) in the past. The story line doesn't change much, but the unit price periodically dips below $60. Some day, perhaps soon, Alliance will cease trading with the volatility of a coal stock. How can I say this? Because Alliance's financial position and business outlook is so far above peers, the company might as well be selling iPads.
This article really does write itself. Whenever the unit price falls below $60, smart investors should be buying it. Earlier in the week the price touched $57, but it has bounced back to near $60 as I write this. That compares to coal producers like Alpha Natural Resources, (ANR), Walter Energy, (WLT), James River, (JRCC) and Arch Coal, (ACI) which have fared worse. James River's earnings did not help either.
Don't Fear Obama or the Fiscal Cliff, Buy Alliance on Dips
In the past few days there's been a lot of talk about Obama's reelection having a profoundly negative impact on coal stocks. That and the scary "fiscal cliff." However, these events do not impact Alliance the same way as others. The use of coal as fuel for electricity generation is not going away. Even if Obama's EPA gets more aggressive, the best positioned coal producers will be the last ones standing.
While coal prices remain weak, coal's mix in the country's electricity consumption profile has improved from earlier this year. From the low 30%s, the percentage of power generation from coal is back to the upper 30%s, albeit still down from the mid-40%s in prior years. This suggests that while the country might be on a fiscal cliff, coal consumption is not.
Alliance in a Class By Itself
Alliance is the ONLY coal producer of significant size in the U.S. that will see a material increase in production next year. Analysts estimate Alliance will produce ~38 million tons in 2013 year vs. ~34 million this year, up about 12%. This is an amazing feat, a testament to strong managerial talent. In fact, the 12% growth is only half of the story.
As the entire industry shrinks while Alliance expands, the company wins in another very important way. Alliance will likely experience flat to lower per ton operating costs due to economies of scale. Few other coal companies will be able to achieve that. A better way to describe this industry dynamic is that no other player will be able to touch Alliance's margins next year.
It's so impressive to me that I have to say this again and again. Alliance is the safest name in the coal space, yet has the highest margins. Think about that. And, it has a 7% yield in a zero interest rate environment. What's not to love?
I believe that Alliance units are under-valued because many investors don't perceive MLPs to have a great deal of capital appreciation potential. This may be true, but Alliance units do have a lot of upside. Here again the article will write itself. If Alliance units were to yield 6.5% a year from now and the annual distribution were to grow by 8%, (historically its been 15%) the unit price would be $72.
One of the Best Risk-Adjusted Chances of a 27% Return, With Limited Downside
A unit price of $72 equates to a 27% total return for a fairly conservative investment. How aggressive is a 6.5% yield assumption? Consider that Alliance units traded in the low $80s in 2011 and the yield was below 4.5%. Since then, medium and long-term treasury rates have fallen dramatically. What if I'm wrong and Alliance units remain at $60 for the 12 months? Then the investor has earned 7%, which is not a disaster.
Unless Alliance runs into serious trouble, a unit price of $60 a year from now on an 8% higher distribution would have the units yielding close to 8%. I don't see that happening. A reasonable, "downside" scenario might be that the units yield 7.5% next year, equating to a unit price of $62.5 and a total return of 11%. Not a home-run, but with Alliance one has a decent shot at a risk-adjusted home-run return of 27% with a reasonable downside of scenario of positive 7%.
Please see my previous articles for more specifics about the outlook for Alliance and how the management team expertly positioned the company for superior returns.
Disclosure: I am long ARLP.