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The 1 Contrarian Coal Stock Killing the Competition

In some ways, Alliance Natural Resources (NASDAQ: ARLP  ) defies all logic of what is happening in the coal space today. The company doesn't do a significant amount of exporting and it has shut in its metallurgical coal. Despite all of these "disadvantages", the company is on track to post its 13th consecutive record year and is running circles around its competitors. How is this possible? Let's take a look at what Alliance does right and what other coal stocks can learn from it.

Taking control of costs
The coal industry in the U.S. is unique compared to other resources because different coal basins in the U.S. run on wildly different economics. While it would be almost impossible for a coal company to survive in the Appalachian region if prices were in the $40 range, that same price would double what coal companies in the Powder River Basin sell for. This makes it rather difficult to give a pure apples-to-apples comparison for many coal companies in the U.S. So instead of looking at pure costs, let's look at gross margins.

Company Coal Production*
Revenue per Ton Sold** Cost of Goods Sold**
Gross Margin
Alliance Natural Resources 9.8 million tons $56 $35.50 36.6%
Peabody Energy (NASDAQOTH: BTUUQ  ) 61 million tons $28 $23 17.8%
Arch Coal (NASDAQOTH: ACIIQ  ) 35 million tons $21 $18 14.3%
Alpha Natural Resources (NASDAQOTH: ANRZQ  ) 22.9 million tons $56 $51 8.9%

Source: S&P Capital IQ, author's calculations. * Most recent quarter. ** Average of most recent quarter.

Alliance has a strong presence in the emerging coal regions in northern Appalachia and the Illinois Basin, which means that the company can command a much higher price for its coal than Powder River Basin producers because shipping costs and quality work in favor of coals from these areas. This makes its product more attractive to coal-powered facilities in the eastern U.S. despite the fact that these coals have a generally higher sulfur content than Powder River Basin coal and are in much more direct competition with natural gas for utility business than in other parts of the country. 

Up until recently, the fact that Illinois Basin and Appalachian coal had a higher sulfur content meant that it couldn't really compete with Powder River Basin Coal due to EPA restrictions on sulfur emissions. So much of the production from these places was deemed unsuitable to consume. Today, though, utility companies are equipping themselves to remove sulfur from emissions, so a higher sulfur coal can be consumed without the implications of higher emissions. In turn, coal companies with a strong position in these regions are getting the benefit of mining more abundant coal seams with a more competitive location. 

What also has set this coal stock apart from its peers is its propensity to focus on organic growth and make smaller acquisitions. Back in 2011, Peabody, Arch, and Alpha all made major acquisitions that eventually led to high debt levels. Debt has drastically affected these companies' bottom lines as coal prices have steadily declined since then. Rather than jumping on the buyout wagon, Alliance has focused on keeping the balance sheet clean and bringing its own new mines on line, delivering rather extraordinary results thus far. 

Putting a ring on prices
Another benefit that Alliance has going for it is a result of the company's structure. As a master limited partnership, the company is very focused on delivering a steady cash flow. The concept is very close to another upstream energy producer that is an MLP, LINN Energy (NASDAQOTH: LINEQ  ) , although the two companies achieve this goal in two very different ways. For LINN, the company writes oil hedges on the open market to ensure a steady cash flow, which can be costly if not hedged properly, and also has them in a bit of hot water lately with the SEC

Alliance has a different approach. The company writes long-term take-or-pay contracts with consumers like utility companies to have a predictable cash flow for several quarters in advance. Today, the company has the rest of its 2013 production sold out and 80% of its 2014 production is under contract. This, to some degree, had shielded the company from weak coal pricing back in 2012, and has helped it stand out among its peers with the numbers it has posted lately. This could prove to be less advantageous if coal prices were to shoot up past those contracted prices, but again the company is more focused on steady cash rather than the big cyclical swings. 

What a Fool believes
Finding a coal stock that has some great upside can be rather difficult. The industry has been hit with a multitude of problems ranging from increased competition from other energy sources for power generation to increased environmental regulations. But, as Peter Lynch has said, its much better to be a great company in a bad industry rather than a good company in a great industry. Alliance could be that kind of company. 

The energy space in the United States is in a state of flux; it is causing disruption across the entire industry. To help you better understand the workings of this changing dynamic, we have put together a special report called "3 Stocks for the American Energy Bonanza". This invaluable report highlights how you can be a smarter investor during this time of rapid movement. Simply click here to access your report -- it's absolutely free. 

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