Power is the lifeblood of a country. But today's power markets are different than they were just a decade ago, and the United States is increasingly seeing the impact of the changes. One stalwart energy industry has been hard hit by the shifts, but there are some players in this hemorrhaging niche that appear positioned to survive.
Power is the key
Modern life wouldn't be possible without electricity. In this country we tend to take our electric plugs for granted, but there are huge changes taking place on the other side of the socket that are having profound impacts on companies in the power industry.
Increasing solar and wind power use, the increasing use of natural gas, and, of course, the increasing attention being paid to carbon dioxide emissions are the big ones. For electric companies, this means shifting the way power is being produced from older technologies to newer cleaner ones. That's great, but the impact on the dirty coal industry has been profound.
For example, the Energy Information Administration recently took a look at the impact that proposed carbon rules would have on coal power production. Absent the rules, coal was expected to provide roughly 34% of U.S. power in 2040. With the rules that drops to 26%. So there's a reason to be worried. Some of the industry's largest players have seen their shares plunge into penny stock territory because of slack demand, falling revenues, heavy debt loads, and high cost operations at some of their properties. However, these changes don't spell doom for all coal miners.
Who might make it?
For example, reduced demand will likely mean the oversupply issues impacting the industry will linger. In that scenario being a low-cost provider will be vital. At the end of 2014, Foresight Energy LP (FELP) operated the three most productive mines in the Illinois Coal Basin, based on tons produced per man hour. It has a big lead, too: its two top mines were more than 25% more productive than the fourth most productive mine in the region based on tons produced per mine hour.
Moreover, control of Foresight was recently purchased by Murray Energy. A giant private coal miner looking to play a dominant role in the industry's future. In Foresight, Murray has a way to raise cash to fund its expansion efforts by selling, or dropping down, coal mines. However, for Foresight this means a growing stream of income as its portfolio of mines grows. So Foresight is a leading low cost coal supplier in one of the key U.S. coal regions and looks like it has a pipeline of acquisitions to fuel growth.
Another dominant player in the Illinois Basin is Alliance Resource Partners (ARLP 0.60%)Unlike competitors, Alliance has been able to increase revenues every year for the past decade, with earnings up in each of the last three years. Compare that to international giant Peabody Energy(ARLP 0.60%) which has seen revenues decline in each of the last three years.
So, Alliance has been able to thrive while competitors have struggled. And that's put it in a position to grow even more in the future. For example, it recently acquired coal assets from a bankrupt miner. So Alliance has proven it knows how to survive in a difficult market and use a downturn to its advantage. And, like Foresight, it operates in the Illinois Basin, which is the cheapest of the major U.S. coal basins when looking at price relative to the energy content of coal.
It's also worth noting that both Alliance and Foresight pay notable distributions because they are limited partnerships. Their 10% yields will pay you handsomely for the risk of investing in an out of favor industry.
Shifting gears
Westmoreland Coal Company (WLB) does things a little differently. For starters it isn't a limited partnership. In addition, and perhaps more importantly, it owns coal mines located near electric utilities. This materially reduces transportation costs, a huge piece of the cost picture for utilities. And that helps explain why customers are willing to sign long-term supply contracts, averaging 10 years. The best part is that its contracts often have provisions that protect it against coal price and volume changes.
So, unlike most competitors, it has a book of business that should see it through to the other side of the coal downturn. In fact, revenues have grown in each of the last three years. And, more importantly, it thinks it can use the downturn to acquire another 10 to 15 mines that fit its business model. Interestingly, it will be able to use a controlled limited partnership to help fund that expansion using the same drop down approach that is likely to benefit Foresight shareholders, only this time you can buy the parent company.
Winners and losers
There are going to be winners and losers in the coal industry. Increasingly it looks like Westmoreland, Foresight, and Alliance are positioning themselves to survive the current industry downturn. While it hasn't been a smooth ride, each company has unique attributes that point to long-term success, including growth potential, operational expertise, and low cost structures. If you are looking for a contrarian investment, each of this trio is worth a deeper dive.
