Coal: Dirty Word, High Yield

07/17/2013 6:00 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Coal is a dirty fuel, and in recent years, it’s become a dirty word for investors, as one producer after another has succumbed to falling prices and diminishing demand, notes Igor Greenwald of MLP Profits.

Cheap natural gas has made major inroads as the fuel of choice for US utilities, and while exports have recently increased they have not made up for the loss of domestic customers.

But one coal producer has not only weathered the collapse, but used it to meaningfully increase its market share and distributions. Alliance Resource Partners LP (ARLP) is only the sixth-largest US producer.

Alliance’s mines in northern Appalachia and the Illinois Basin are the lowest cost producers in the Eastern US, well placed to capture market share from natural gas at gas prices even well below current levels.

Under the leadership of Oklahoma billionaire Joseph Craft III, Alliance has made profitable investments that have grown its production and distributions to limited partners.

Output grew from less than 26 million tons in 2009 to an expected 39 million tons in 2013. ARLP’s distributions per share have also increased by roughly 50 percent in that time, and are expected to approach $4.50 per unit this year.

Alliance has been growing its top and bottom lines even as US coal prices plumb multi-year lows. It operates 11 underground mines in Illinois, Indiana, Kentucky, Maryland and West Virginia, is building a 12th in Southern Indiana and is an investor in another new mine in southern Illinois.

The vast bulk of the output is sold to utilities under long-term contracts with periodic price adjustment provisions. Louisville Gas & Electric and Tennessee Valley Authority accounted for 28.5% of Alliance’s revenue last year.

Alliance operates entirely with a non-unionized workforce and believes its workers’ productivity is a competitive advantage.

Alliance Resource Partners is managed by its general partner, Alliance Holdings GP LP (AHGP), which holds 42% of the ARLP common units and collects incentive distribution rights.

These rights entitle Alliance Holdings to 15 percent of quarterly ARLP distributions in excess of 27.5 cents per unit, 25% above 31.25 cents per unit and 50% above 37.5 cents per unit.

Since ARLP paid a quarterly distribution of $1.13 in May, its general partner is well into the upper bound of the bonus scheme and entitled to half of any further growth in distributions.

Alliance Holdings’ incentive distribution rights (IDRs) totaled $102 million last year, up from $83 million in 2011 and $67 million in 2010.

That growing income stream supports AHGP’s current 4.9% yield, and its 21-quarter streak of distribution increases. IDRs should account for well over half of ARLP’s distributions to AHGP this year.

The underlying business is strong and improving. In its most recent quarter, ARLP reported a 15% output gain year-over-year, and a 23% revenue gain thanks to higher selling prices.

Even in the absence of higher prices, Alliance’s investments in new mines should boost affiliated production by up to 20 percent over the next two years.

More encouragingly still, this is not growth financed by spiraling debt. Alliance Resources boasts a debt-to-trailing-EBITDA ratio of 1.3, versus 2.7 for coal MLPs and 3.9 MLPs as a whole.

The combination of low leverage, solid 6% yield, profitable growth, and improving industry fundamentals marks Alliance Holding GP as a winner. We’re adding AHGP to our Aggressive Portfolio.

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