The energy sector has had its ups and downs in recent years. However, despite the most recent downturn, worldwide demand for energy continues to rise, which should eventually take commodity prices up with it. Because of that, investors stand to make a tidy profit by investing in companies poised to capture this growing demand, especially those with unique niches in the sector. Three such hidden opportunities are Alliance Resource Partners (ARLP 1.60%), Summitt Midstream Partners (SMLP 2.16%), and Clean Energy Fuels (CLNE 11.59%). Here's why we think they could fuel big-time profits for investors in the coming years.
Good while it lasts
Tyler Crowe (Alliance Resource Partners): Investing in coal today isn't much a bet on the future of energy. Rather, it's a bet that the future of energy is going to take a while to get here. As much as cheap natural gas and renewable energy has hacked away at coal's dominance as the fuel of choice for the electricity market, it still is responsible for 28% of all electricity generation in the United States. Pretty much every new power-generating facility in the U.S. today runs on natural gas or renewables, but there is still a large established base of coal-fired plants that will be around for a while during this transition phase.
Of the coal-producing companies out there, few are in as good of a position -- both competitively and financially -- as Alliance Resources Partners. The company's coal mines in the Illinois Basin are some of the lowest-cost facilities in the country and are projected to increase output while legacy mines in Appalachia and the Rocky Mountains decline. So even if we see a drop in coal consumption over the next several years, Alliance is much less affected than others.
On top of that, Alliance is an incredibly well-capitalized business that throws off lots of capital to its shareholders. The company avoided the temptation to spend on new mines at the top of the commodity cycle in 2011, and it has a distribution coverage ratio -- a measure of an MLPs payout sustainability -- that suggests it can keep paying investors for quite some time.
By no means is Alliance, or the coal industry in general, a buy and hold forever kind of investment, but the sunset for coal is going to take a while, and Alliance's 8% distribution yield today can make a decent return over the next several years.
Building a nice niche
Matt DiLallo (Summit Midstream Partners): With a sub-$2 billion market cap, Summit Midstream Partners is just too small to catch the eye of most investors, especially since most other midstream companies spend that much each year on growth projects. That said, Summit Midstream Partners has established itself as an important niche player by providing gathering and processing services to producers across most of the country's shale plays. The company collects stable fees from these services since minimum volume contracts back the bulk of its assets. In fact, 98% of its income comes from fees. Because of the stability of its cash flow, Summit can send a big chunk of it back to investors, which is why its units currently yield an eye-catching 9.6%.
Typically, a yield that high would be a cause for concern, but that doesn't appear to be the case at Summit. That's because the company expects its coverage ratio to be a comfortable 1.2 times at the midpoint of its guidance this year. Further, its leverage ratio was 4.35 times in of the first quarter, which is fairly conservative for a midstream company. If there's any concern, it's the fact that Summit owes its parent company a deferred payment of more than $800 million in 2020 to pay for a drop-down acquisition it completed last year. That said, it has plenty of time to raise the necessary capital, which reduces its risk.
Meanwhile, the company continues to expand its niche by securing new organic growth projects. Earlier this month, for example, the company secured a deal with an ExxonMobil (XOM 0.82%) subsidiary for a $110 million gathering and processing system in the red-hot Permian Basin. That facility not only will give Summit another stable cash flow stream starting next June, but it gives the company a platform to grow in that important basin.
Given the company's solid financial position, and the ability to capture needle-moving growth from smaller investments, Summit Midstream Partners is a gem that could deliver excellent growth and income in the coming years, especially considering its embarrassingly cheap valuation these days.
After years of tumbling, this natural gas provider is set to shine
Jason Hall (Clean Energy Fuels Corp): Since peaking in early 2012 above $22.50, shares of Clean Energy Fuels are down almost 90%, and only a recent rally has them approaching $3 again.
And not for no reason -- after all, the company has issued a huge quantity of new shares over the past 18 months, and it hasn't produced a profitable full year (on a GAAP basis) in more than a decade:
Furthermore, low oil prices have impacted its near-term growth prospects, since cheaper diesel and gasoline reduce the financial incentive for vehicle fleet operators to make the move to natural gas.
Despite these negatives, I think now's an excellent time to invest.
To start, the balance sheet (once a weakness) is solid, having used all those shares issued to pay off nearly $200 million in debt. The company last reported $221 million in cash and $257 million in debt, down more than half. Combined with double-digit cuts in SG&A and capital spending (while still funding new station growth), this is the leanest the company has been in years.
With full-year expenses on track to be even lower in 2017, while fuel sales keep growing, look for the results to keep improving. GAAP profits may still be a year or two away, but -- more importantly -- cash flows are already positive and set to grow.