Please ensure Javascript is enabled for purposes of website accessibility

Alliance Holdings GP Is Running Out of Room to Grow...What's Next?

By Reuben Gregg Brewer – Nov 17, 2016 at 9:22AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Alliance Holdings is responsible for running coal mines, which isn't such a great business these days. What's next?

Alliance Holdings GP, L.P. (NASDAQ: AHGP) is the general partner of Alliance Resource Partners, L.P. (ARLP 2.74%). In simple terms that means Alliance Holdings runs Alliance Resource Partners' coal business. That looks like a dying business...or is it? Here's what's next for the coal miner.

Alliance Resource Partners employees working in a mine. Image source: Alliance Resource Partners.    

The relationship

To understand Alliance Holdings GP, you first have to understand its relationship with Alliance Resource Partners. Essentially, Alliance Holdings earns a fee for running Alliance Resource Partners' day-to-day coal business. In addition to this, it gets incentive payments for increases in Alliance Resource Partners' distribution, aligning Alliance Holdings with unitholders looking for long-term distribution growth. The GP also owns shares in Alliance Resource Partners, so it earns distributions, too, just like every other unitholder.

There are two big takeaways here. First, Alliance Holdings is a play on coal. Second, Alliance Holdings is leveraged to Alliance Resource Partners' success because of the incentives it receives for distribution growth. Today, however, a struggling coal market has been the bigger issue. In fact, concerns about weak coal markets were a driving force behind Alliance Holdings and Alliance Resource Partners cutting their distributions earlier in the year.

In other words, if you are looking at either stock as an investment in Alliance, you need to wonder if the coal industry has run out of room to grow, curtailing the long-term future of these two partnerships along with it.

An Alliance Resource Partners coal mine. Image source: Alliance Resource Partners.   

Trump can't save coal

The first thing to look at here is the near-term picture. Trump being elected to the U.S. presidency could turn out to be a boost for coal, which has seen increasing competition from renewable power like wind and solar. Those two power options have received a great deal of support from the U.S. government over the years. If that support dries up, coal's near-term outlook could brighten. This is why Alliance Holdings rallied more than 5% the day after the election.

But don't get too excited; the bigger problem for coal has really been natural gas. That fuel has been so cheap lately that it's made more economic sense to build gas power plants than coal plants. Add in the fact that gas burns cleaner than coal, and coal still has big problems to deal with even if renewable power loses some of its luster.

It isn't all the same

But here's the thing: Not all coal is created equal. Alliance is focused on the Illinois Basin coal region. The type of coal that Alliance mines has been taking market share from other regions for years. In fact, for a long time Alliance was able to increase production while others were trimming because demand remained strong for the type of coal it produces. And while 2016 has been a difficult year for Alliance on the demand front since it's sold nearly 14% less coal through the first nine months of year compared to 2015, the long-term demand picture isn't expected to change for the coal it produces.   

For example, the U.S. Energy Information Administration (EIA) creates projections for three coal regions. Two are expected, even in the best-case scenario, to see notable demand declines out to 2040. And falling demand for West and Appalachia coal is expected to account for the vast majority of coal's production declines out to 2040 in the worst-case scenario.   

EIA coal projections out to 2040. Image source: U.S. Energy Information Administration.   

The Interior region, which includes the Illinois Basin, however, is expected to see demand increase (slightly) even in the worst-case scenario, with a peak in 2019 and modest declines thereafter. Demand actually does quite well, relatively and on an absolute basis, in the best case. The best case just got a little more likely with the election of Trump.

Take it!

What this says is that coal, overall, is going to continue to struggle. That leaves little room for Alliance Holdings and Alliance Resource Partners to grow...unless they steal market share from other companies. And that's the real story to watch at Alliance.

Stealing market share, however, is exactly the plan it had been executing successfully for years leading into 2016. Now that the coal business has started to shake out with bankruptcies and mine closures, Alliance just needs to keep moving down the same path it always has. So, with the coal industry set to contract, keep an eye on Alliance Holdings and Alliance Resource Partners' ability to execute better than peers from other regions, as Alliance Holdings tries to take market share from competitors--just like it has been doing for years.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners. 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.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.