Alliance Resource Partners, L.P. (NASDAQ:ARLP) might have the best set of coal assets for the current regulatory environment. The company engages in the production and marketing of coal and operates 11 underground mining complexes in the Illinois Basin, Central Appalachian, and Northern Appalachian regions. The key to success is the lower costs of the Illinois Basin coal that has a cost advantage now that electric utility scrubbers allow for the use of the high-sulfur coal to meet EPA regulations.
The recent spike in natural gas prices due to lower inventories will force utilities to switch back to cheaper coal, especially the coal from the advantaged Illinois Basin and Northern Appalachian where Alliance Resource focuses. The master limited partnership, or MLP, will benefit unitholders looking to cash in on the 6% distribution and future growth. For speculative investors, the beaten down coal stocks of Peabody Energy (NYSE:BTU) and Arch Coal (NYSE:ACI) might benefit the most from a gas-to-coal switch. Investors in those stocks are exposed to much higher risks, where as Alliance Resource Partners is likely to continue taking market share regardless of the coal market environment.
First and foremost, Alliance Resource Partners is an MLP that is required to distribute the majority of its income. The company currently distributes $1.175 per unit, or roughly a 6% yield.
The distribution should continue to grow based on the growth catalysts listed below, and the potential for higher natural gas prices going forward. If electric utilities switch back to using coal for power generation, coal prices should jump. For next year, Alliance Resource already has 32.6 million tons priced and committed, but it should leave up to 10 million tons left to participate in price increases.
What really sets Alliance Resource Partners apart from the coal industry is that it continues to develop new mining resources while the industry is cutting capacity.
Alliance Resource Partners expects to grow production at the Tunnel Ridge mine to 5.5 million tons in 2014 while the new Gibson South mine is scheduled to begin initial production by the third quarter. At the same time, longwall production at the While Oak mine development project is anticipated to begin in the second half of next year.
The Tunnel Ridge mine only produced 2 million tons of coal in 2012 so reaching the goal of 5.5 million tons next year will be a significant increase over that time span.
The Gibson South mine will be an underground mine utilizing continuous mining units. Annual production is expected to reach 3.0 to 3.5 million tons in 2015 and approximately 5.2 million tons in 2016.
The White Oak mine includes a preferred equity investment in White Oak Resources and a royalty income stream for 200 million tons of coal. In addition, Alliance Resource Partners will operate the preparation facilities and will receive a throughput fee on all feedstock coal processed.
Scraping the bottom for profits
While Alliance Resource Partners is busy distributing income to unitholders of the MLP, Peabody Energy and Arch Coal have been cutting capacity hoping to generate profits.
In the last quarter, Peabody generated only $0.06 of adjusted earnings from $1.8 billion in revenue. The totals are down substantially from the adjusted earnings of $0.53 and over $2 billion in revenue in the corresponding period last year. These numbers even consider that Peabody benefits from Australian operations that feed the power hungry China market.
Similar to Peabody, Arch Coal reported substantially lower numbers compared to last year during the third quarter. Arch actually dropped to a loss in the third quarter of this year after reporting a $0.20 profit last year. As well, revenue plunged to below $800 million compared to $975 million last year.
These drastically different results highlight the dichotomy in the current coal market. Alliance Resource Partners should continue grabbing market share by adding production capacity via the new mines. Peabody Energy and Arch Coal should see profits and consequently see their stock bounce back significantly more if natural gas prices continue rising and gas-to-coal switching expands.
Ultimately, all coal stocks will benefit to different levels if natural gas prices continue to surge. Alliance Resource remains the conservative way to play the switch. It is the one coal stock where Investors will continue to prosper even if the switch back to coal doesn't occur.
Mark Holder has no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.