2 Ways Coal Can Still Make You Rich

Few industries have been more brutalized in recent years than coal. However, this article explains how long-term investors can still make a killing in this unloved but still lucrative industry.

Jul 1, 2014 at 1:50PM

Whether its new EPA regulations requiring the coal industry cut CO2 emissions by 30% (from 2005 levels) by 2030 or natural gas power plants replacing coal fired ones, the coal industry has faced a brutal couple of years.

WLT Total Return Price Chart

WLT Total Return Price data by YCharts

Take metallurgical pure play Walter Energy (NASDAQOTH:WLTGQ) for example.

Back in 2011 when metallurgical coal, (used to make steel) was at a high of $350/ton, Walter Energy acquired high-cost Canadian coal miner Western Coal for $3.3 billion.

Today due to soft demand from China and new supply from Australia, metallurgical coal is trading for $120/ton and Walter has had to: cut its dividend 90%, shut down its Canadian mine and attempt to cut administrative expenses by 10% this year.

Walter' Energy's biggest problem is its massive debt load of $2.4 billion, in the form of bonds with interest rates of 8.5%-11%. With a debt/adjusted EBITDA ratio of 24 and the company hemorrhaging cash, Walter will deplete its cash reserves by the end of 2015. This is why the company's bonds are trading for 60% of face value (yielding 20%) and 65% of the company's shares are held by short sellers.

The only way Walter Energy survives is if it either sells more shares and dilutes shareholders as it's been doing at an annual rate of 5.3% since 2006 (see the chart above) or if metallurgical coal prices rebound.

Walter Energy: speculative commodity bet
This is pretty much what investors in Walter Energy are now doing, making a speculative commodity bet that metallurgical coal will rebound before the company's cash runs out. Given its massive short interest and the fact that each $1/ton increase in metallurgical coal price is worth about $10 million in EBITDA, this is a bet that may pay off handsomely. For example, should metallurgical coal rebound to $175/ton, Walter Energy's EBITDA would soar to $715 million, its debt/EBITDA would fall to 3.36, and it could easily service its debts. This would likely send the share price soaring several fold in the short-term.

However, here at The Motley Fool we believe in owning high-quality companies with solid management teams and good growth prospects. That is why I don't recommend Walter Energy but rather Alliance Resource Partners (NASDAQ:ARLP) and its general partner Alliance Holdings GP (NASDAQ:AHGP).

Alliance Resource Partners: the king of low-cost coal

ARLP Total Return Price Chart

ARLP Total Return Price data by YCharts

Unlike Walter Energy, which has returned -4.5% annual total returns over the last 15 years (vs the greater market's 8.8%), Alliance Resource Partners and Alliance Holdings have proven to be very good at making long-term income investors rich. For example, Alliance Holdings in the last 10 years has nearly tripled the market (20.6% annual returns vs 7.7%) while Alliance Resource Partners, over the last 17 years has beaten the market by 583% (31.4% annual returns vs 4.6%).

While I don't expect either security to continue with such sky-high returns, there are three reasons I believe Alliance Resources can outperform the market in the long-run and make income investors very rich.

The first reason is because Alliance Resources has some of the best, lowest-cost reserves in America in the form of its 14 Illinois and Appalachia mines.

With coal fired electricity production up 15.1%, overall coal consumption up 12.6%, and utility coal reserves down 28% this year, it seems a bottom has formed in the coal market.

Alliance Resource Partners, which has reported 13 consecutive years of record production and revenues (as well as 24 consecutive quarters of distribution growth) is well poised to continue its impressive winning streak.

Specifically it has three projects: two new mines (Gibson South and an investment in the White Oak mine) and one expansion (Tunnel Ridge longwall), that will result in a 29% increase in coal production by 2016.

What's more, Alliance Resource Partners has proven itself a master at cutting costs, with production costs at Tunnel Ridge dropping 29% this quarter.

The second reason for investing in Alliance Resource Partners is because management has proven itself skilled at protecting the balance sheet and unit holder wealth. Consider this:

  • Alliance Resource Partners hasn't had a secondary offering since 2003 (almost unheard of with MLPs).
  • Its leverage is remarkably low with a debt/EBITDA ratio of 1.2 vs 3.9 for MLPs and 7 for the coal industry.
  • Its distribution coverage ratio over the last year is 1.58, representing a bank-vault like distribution/dividend security and portending strong growth in years to come.

Which brings me to the final reason for investing in Alliance Resource Partners: the generous yield of 5.3%, which analysts predict will grow at 8.5% for Alliance Resource Partners and 9.8% for Alliance Holdings for the next 10 years.

With dividend/distribution growth like that long-term investors can expect total returns of about 14.5%-15.9% annually over the next decade.

Foolish bottom line
Walter Energy represents the kind of short-term, speculative coal play I'd recommend investors avoid. Alliance Resource Partners on the other hand is the epitome of a Foolish investment. It represents a best of breed company with impeccable management, a rock-solid balance sheet, and a Volvo-safe dividend/distribution set to grow strongly over the next decade. 

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information

Compare Brokers