Alliance Resource Partners: Entering A New Era Away From Thermal Coal
- After growing their distributions during 2021, Alliance Resource Partners provided another 40% increase to start 2022 thanks to booming coal prices.
- Even more excitingly, they have also announced two new investments in non-resource related business ventures, which see them moving away from thermal coal.
- This sees their partnership entering electric vehicle charging and proprietary lightweight electric motors.
- Management expects to see "significant" returns in four to seven years whilst investing at least $90m in the short term, which will see a sizeable draw upon their cash inflows.
- I still believe that maintaining my hold rating is appropriate given the uncertain outlook for these new business ventures and the risks when these booming coal prices likely revert lower.
Thanks to a surprisingly strong rally in coal prices during 2021, the thermal coal-focused Alliance Resource Partners (NASDAQ:ARLP) was able to reinstate and subsequently grow their distributions during the year whilst also seeing an outlook for even higher distributions in 2022, as my previous article expected. They did not disappoint with 2022 already seeing a very impressive 40% distribution increase that if continued, would see a high yield of 7.90%. Even more excitingly, management has also announced two new investments in non-resource related business ventures that see them entering a new era away from thermal coal, as discussed within this follow-up analysis that also reviews their recently released first quarter of 2022 results.
Executive Summary & Ratings
Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.
*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and also best captures the true impact upon their financial position.
Whilst 2021 was a surprisingly strong year for coal, both thermal and metallurgical, 2022 started even stronger with booming prices following the Russian invasion of Ukraine and the resulting sanctions levied upon the former, which sees Europe banning Russian coal imports. Unsurprisingly, this saw the financial performance of coal producers surge and as a result, their operating cash flow during the first quarter of 2022 reached $89m, which represents a very impressive increase of 62.93% year-on-year versus their previous result of $54.6m during the first quarter of 2021. Whilst positive, their higher capital expenditure of $59.2m and further $4.5m of miscellaneous cash expenses, as detailed beneath the graph include above, left their free cash flow of $25.3m insufficient to cover their distribution payments of $32.8m.
Thankfully, when digging deeper, this would not have been the case if not for their temporary working capital movements that weighed down their cash flow performance. Even though their quarterly results do not provide details on their working capital movements, they can still be estimated based on changes in their relevant current assets and liabilities. If aggregating the changes in their accounts receivable, inventory and prepaid expenses during the first quarter of 2022, it shows an increase of $60.5m. Meanwhile, if doing the same process for their accounts payable, accrued taxes, accrued payroll and accrued interest, it shows an increase of $22.6m. Since their current assets increased more than their current liabilities, it indicates a working capital build of circa $38m. If this had not occurred, their free cash flow would have been circa $63m, which would have provided very strong near 200% coverage to their distribution payments, thereby indicating impressive underlying financial performance. Whilst this was expected given these booming coal prices, the bigger surprise was their move into non-resource related business ventures with two new investments, as per the commentary from management included below.
"We are excited to announce today, our recently completed investments in two entrepreneurial companies, Francis Energy and Infinitum Electric."
"We believe both of these investments will provide significant returns for our unitholders within four to seven years."
"Combined, we plan to invest up to $90 million over the next 12 months in these investments."
-Alliance Resource Partners Q1 2022 Conference Call.
After only ever providing generic and thus lackluster details regarding their future strategy to navigate the clean energy transition, as discussed within my earlier article almost one year prior, it has been very positive to management seize upon these booming coal prices to finally take this necessary action. The first company, Francis Energy provides electric vehicle charging infrastructure, whilst Infinitum Electric owns proprietary technology for lighter weight electric motors, thereby lining up an expansion into non-resource related businesses for the first time.
Despite seeing them enter a new era away from thermal coal, which is exciting from a long-term perspective, investors should still keep their expectations tempered since it remains to be seen exactly how profitable these business ventures will become. In the short-term, it seems reasonable to expect very little with management planning "significant" returns within four to seven years, which could help elevate one of my core concerns discussed within my previously linked article as they see more coal power stations shut down in the future. Since the terms of the transactions are not disclosed, it seems unitholders will have no choice but to sit back and wait, although given their plans to invest upwards of $90m over the next year, these will see a sizeable draw upon their cash inflows.
After seeing their net debt plunge more than $200m during 2021, it subsequently edged slightly lower during the first quarter of 2022 to $303.2m versus the $312.6m where it ended 2021 thanks to various relatively minor financial asset movements and divestitures. Although, if not for their estimated $38m working capital build, their net debt would currently be sitting an impressive circa 10% lower at approximately $265m, which may be forthcoming during the second quarter if their working capital build reverses into a draw.
Whilst it appeared that they would reach zero net debt during 2022 when conducting my previous analysis following the third quarter of 2021, this no longer appears to be the case. The extent to which their net debt decreases when looking ahead into the remainder of 2022 will obviously depend upon the inherently volatile coal prices, apart from the possible one-off boost from their working capital build reversing. Although even if coal prices remain very strong, given their prospects to pump upwards of $90m into their new business ventures on top of their usual coal-related capital expenditure and distributions, it leaves further deleveraging looking unlikely to any significant extent but thankfully even at circa $300m, it now remains well below its previous level of $744.9m at the end of 2019.
Following the booming coal prices seen throughout the first quarter of 2022, it was no surprise to see their leverage plunging with their net debt-to-EBITDA now sitting at only 0.17 and thus obviously well below the threshold of 1.00 for the very low territory. When looking at their net debt-to-operating cash flow of 0.85, which remains significantly higher and thus diverged from tracking their net debt-to-EBITDA as normally observed, it further indicates a sizeable working capital build weighing down their operating cash flow.
Whilst their net debt may cease decreasing going forwards, thankfully it is already down significantly versus its previous levels and as a result, their leverage would still remain very low even if these booming coal prices were to revert lower. If overlaying their EBITDA from 2019 and 2020 against their current net debt of $303.2m, it sees their net debt-to-EBITDA at 0.51 and 0.78 respectively, which clearly remain easily within the very low territory, thereby lowering the risks as they enter this new era of non-resource related business ventures.
When looking elsewhere, their lowest leverage in recent history since at least the end of 2019 is also accompanied by their strongest liquidity in recent history, which now sees their current ratio climbing to 2.00, whilst their cash ratio also remains strong at 0.63. Despite their liquidity remaining strong, as a thermal coal-focused partnership, their ability to access debt markets in the future is rather cloudy as more financial institutions shy away from the sector on ESG grounds, which actually provides another avenue that their new business ventures could possibly help, especially, Francis Energy. Since they operate electric vehicle charging infrastructure, Alliance Resource Partners may be capable of utilizing this connection to improve their ESG credentials and thus access debt markets in the future if they wish. Either way, thankfully they only see minimal debt maturities until 2025 and thus have breathing room to pursue these new business ventures before repaying or refinance their debt, as the table included below displays.
After providing nothing but lackluster and scant details on their plans to diversify away from thermal coal, it has been positive to see management seize upon their booming earnings to finally take this necessary action, thereby entering a new era with their investments in Francis Energy and Infinitum Electric. Despite being positive, I nevertheless still believe that maintaining my hold rating remains appropriate given the uncertain outlook for these new business ventures and the possible downside risk once these booming coal prices more than likely revert lower in the future.
Notes: Unless specified otherwise, all figures in this article were taken from Alliance Resource Partners' SEC filings, all calculated figures were performed by the author.
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