Alliance Resource Partners, L.P. (NASDAQ:ARLP) is perhaps the best run thermal coal company in the United States. But coal is slowly losing its place in the electric grid. There's no immediate danger to Alliance's business, but that doesn't mean it's sitting still. Which is why you'll want to keep an eye on its efforts to push into new areas, like midstream and oil and gas.
Time to spare
There's no point in ignoring the obvious: coal is being displaced by cleaner burning natural gas and renewable power options like solar and wind. Gas has been the real winner here because low gas prices have made it cost competitive with coal. At this point too much has changed for coal to gain back a significant share of the power market. But the transition away from coal is a relatively slow one.
For example, the U.S. Energy Information Administration projects that coal will remain an important part of the power sector until at least 2040, and likely beyond. Further, it expects the Interior Region, which is where Alliance's business is focused, to increase its share of the coal market from 20% to 26% over that span. So there's no immediate threat to Alliance's business.
Alliance, meanwhile, is a conservatively run partnership. For example, long-term debt makes up only about 25% of the miner's capital structure. And it has a current ratio, a measure of a company's ability to pay its near-term bills, of a respectable 1.1. It expects to cover its distribution by around 1.7 times this year even after a recent 14% distribution hike. That's a huge margin of safety in an industry where coverage of 1.2 is considered good. And it's worth noting that, despite a deep coal downturn, Alliance has remained profitable while peers have careened into bankruptcy court.
Unless something goes disastrously wrong, Alliance is in a good position to thrive in the years ahead. And it has plenty of time to deal with the long-term implications of operating in a slowly declining industry.
Hints of change
But what, exactly, is Alliance doing? In the second quarter, the partnership announced that it had purchased a $100 million preferred interest in Kodiak Gas Services, LLC, a privately held gas compression company. The deal, according to CEO Joe Craft, was opportunistic and complementary to Alliance's coal business. It's expected to be immediately accretive.
Alliance is also targeting about $20 to $30 million of investment in oil and natural gas royalty assets this year. It holds a majority position in a relatively small oil and gas royalty business. So far it's contributed about $145 million to the operation since late 2014. At this point, Alliance views these investments as a way to support its coal business. In fact, it doesn't even break them out in its financial statements.
With at least 20 years before coal is in danger of falling out of the U.S. power grid, Alliance has plenty of time to adjust. And these investments are tiny right now, giving the coal miner a chance to get its feet wet. Which is a good thing when you consider that Ferrellgas Partners' (NYSE:FGP) quick expansion into the midstream business didn't pan out very well. That propane distributor levered up to buy assets that eventually struggled, leaving it with little choice but to cut its distribution by a massive 80%. It's now focused on fixing its balance sheet.
At this point, Alliance's investments in the midstream and oil and gas royalty areas are little more than footnotes to its main business. But management isn't blind to what's going on in the coal industry. I expect it will continue to make small additions to these new areas to diversify its operations. For now, you'll have to pay attention to the details to see what's going on.
But over time, I think the non-coal businesses will grow in importance. And they could, given the long-term trends in the coal industry, end up being the foundation that allows Alliance to thrive even as coal continues its long-term decline. To be clear, that's not a near-term expectation... but these investments are definitely something you should start watching now.