Alliance Resource Partners: A Buy Amid A Strong Expansion Focus

Summary

• Alliance Resources has increased its cash levels by more than 224% since June 2021.
• Alliance's election to convert Alliance Minerals into a corporate taxable entity will lower the company’s tax on its oil and gas royalty. This taxation reduced net income by $42 million.
• Production on the company's acreage has substantially increased, leading to an increase in drilling and completion activities.
• The company is considering opportunities in mining beyond thermal coal to include metallurgical coal. It is also looking at EV charging, Smart cameras, energy storage, energy efficiency and renewable energy.

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Alliance Resource Partners (NASDAQ:ARLP) has gained more than 220% over the past year with the wider energy sector experiencing phenomenal growth with the rising inflation.

Seeking Alpha

Arch Resources, Inc. (ARCH) has gained 270.93% since 2021, Peabody Energy (BTU) increased 478% while Energy Fuels (UUUU) is up 33.58% in the same period. This growth outperformed expert concerns that the coal market is facing a bleak future. The push to regulate the emission of greenhouse gases by environmental activists, regulators and global governments cannot be ignored. Still the resilience of this industry shows investors are pumping money into coal stocks amid expectations of robust economic recovery.

Thesis

Alliance Resource Partners' projects higher coal export prices from the domestic market in 2023. This expectation will likely see the company increase its export volumes next year with a strong guidance in the full year 2022. Investors should also expect a higher average product pricing as the company is on a mission to reinvest its free cash flow into additional oil and gas minerals. Under investment in the production of fossil fuels since 2019 as caused by the Covid19 pandemic and increasing government climate policy decisions caused a global shortage of coal, oil and natural gas. In my view, ARLP's focus on the international market including a broader investment into EV charging, smart metering and energy demand management makes this stock a buy.

Q1 2022 review

In its Q1 2022 earnings release, ARLP's quarterly cash level rose the highest to $122.4 million. It gained 17% (QoQ) despite the fact that it stood at a meagre $37.7 million as of June 2021. From Q2 2021, the company has increased its cash by more than 224%.

Sales price of a ton of coal jumped 13% in the quarter with oil & gas prices gaining 74.9% per BoE. Royalty revenue for coal also rose 9.2% per ton. All these made ARLP's total revenue to rise 44.6% at $1.712 billion while income before taxes rose 221%. EBITDA was up 61.5%. The main challenge (from a financial side) that reduced these improvements was a delay in coal shipments of 1.1 million tons. It reduced coal revenues in the quarter by $72 million, EBITDA missed the target by $31 million while net income fell by $27 million.

Still the company registered impressive numbers. In the year ending December 2020, ARLP's net loss stood at $129.2 million. By Q1 2022, the company's net income had grown to $185.3 million (more than 240% increase in net income in just 2 years).

Of special note is that the net income was also reduced by $42.1 million (after a one-time non-cash deferred tax charge of $37.3 million and a current income tax expense of $4.8 million). The tax charges were as result of ARLP's conversion of Alliance Minerals to a corporate taxable entity for the federal and state income tax purposes. The revelation here is that net income would have crossed the $230 million mark in the first quarter of 2022 alone.

ARLP's election to convert Alliance Minerals into a corporate taxable entity will help lower the company's tax charge on its oil and gas royalty revenue. Rather than paying entity level taxes at higher individual tax rates, ARLP will pay lower corporate tax rates. Income tax expenses as of December 2021 stood at $0.4 million and have ridden on negligible levels since the company's formation. But with the renewed call to lower greenhouse gas emissions, ARLP had no other choice but to include this upgrade. Further, the company intends to reinvest its free cash flow from Alliance Minerals into additional oil and gas mineral developments. This upgrade will prevent the company from being double-taxed going forward.

There was a meaningful improvement in the pricing of oil and natural gas in the quarter that led to an increase in revenue. Oil topped $100 per barrel while natural gas crossed the $7 MMBtu for the first time in a decade.

High production in inflationary times

Production on ARLP's acreage has substantially increased leading to an increase in drilling and completion activities. As a matter of fact, production in the quarter was up 14.7% higher (YoY) and +5% (QoQ).

An upsurge in production shows Alliance Resource was able to surmount the rising inflation, which is up 8.5% (as of April 2022), supply-chain bottlenecks, free long-haul movements and staffing challenges. In all fairness only the occurrence of a global recession as was caused by the Covid-19 pandemic is able to limit the demand for fossil fuels. Evidently, commodity pricing will remain strong for years to come. ARLP has also pegged its hope on the commitment of the US to increasing LNG exports over the next decade.

EIA

According to the EIA, the US began exporting more natural gas than it imported in 2017 on an annual basis. It has led to a consistent increase in exports of pipeline and liquefied natural gas (LNG). Forecast shows that LNG exports will average 12.2 billion cubic feet per day (Bcf/d) in 2022. By then it will surpass Australia and Qatar and top the global LNG export industry. Further, LNG exports are expected to increase by 2.4 Bcf/d in 2022 and by 0.5 Bcf/d in 2023. These numbers support ARLP's likely dominance in the LNG space.

As we can deduce, gas demand in Europe is evidently high as the continent tries to lower its imports from Russia following the latter's invasion of Ukraine. In the first four months of 2022, Europe was the top importer of U.S LNG taking up 65% of US exports. What's more, the Biden Administration struck a deal to boost its LNG supply to Europe. In the agreement, the US, pledged to supply an additional 15 billion cubic meters of LNG in 2022.

Europe is reportedly spending more than $1 billion per day on coal, gas and oil imported from Russia. The belief that this expenditure is indirectly funding the war in Ukraine is driving many EU countries to not only boost investments in renewables but also move away from Russia. The US and Australia are said to have the capacity to replace 70% of the Russian coal that is imported into the EU even as prices run above $400 per ton.

Broader investments

To achieve its production growth matrix by more than 5 times and raise shareholder value, ARLP has earmarked various areas of potential investment. In its Q1 2022 earnings, the company CEO Joe Craft stated

We are looking to allocate capital expenditures towards high return efficiency projects to maintain our low cost competitive advantage. In addition, we will consider opportunities in mining beyond thermal coal to include metallurgical coal and other industrial minerals to capitalize on one of our core competencies, our mining expertise. These investments include: Smart cameras, energy storage, energy efficiency, renewable power generation, EV charging, smart metering and energy demand management."

The company is focused on returning cash to its unit holders with its dividend yield (TTM) at 3.67% with a forward yield of 7.90%. Despite losing 17% in its five-year dividend growth rate, ARLP aims to have its allocations for distributions at 30% of its estimated annual free cash flow. It has maintained a 14.54% 4-year average dividend yield since 2016.

Risks

ARLP's year-end yield in its dividend growth declined from 22.09% in 2019 to 9.54% in 2020. At the time, the annual payout growth rate also reduced by 81.35%.

ARLP's total liabilities since December 2021 has increased from $933.3 million to $992.2 million (an increase of more than 6% in just a quarter). However, the company was able to lower its debt by $3 million and raise its book value per share by 0.6%.

The company is reeling from an increase in segment adjusted EBITDA expenses per ton of coal. It grew by 10.7% in Q1 2022 to $32.90/ ton from $29.72 in Q1 2021. To curb the inflationary pressure including supply and maintenance costs, the company has maintained its trimmed labor supply at 895 employees from a high of 3,602 in 2019. However, net income has declined by 52.4% since 2019 from $399.4 million to $190.2 million.

Bottom line

Despite a decrease in its dividend growth history, ARLP has maintained a 14.54%, 4-year average dividend yield in a bid to return cash to its unit holders. Investors have also gained +200% over the past year showing the stock's resilience in a high inflationary environment. The company also intends to invest in high-return efficiency projects and royalties to maintain its low-cost competitive advantage. Still, coal remains an attractive venture to the company with clients such as Europe moving away from Russian coal. Further, ARLP is confident of higher commodity pricing due to the increase in US LNG exports over the next decade. For these reasons we propose a buy rating for the stock.

Disclosure: I/we have a beneficial long position in the shares of ARLP either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.