Most industries go in and out of favor over time, but along the way some end up completely disappearing. While it's way too soon to suggest that Alliance Resource Partners' (NASDAQ:ARLP) coal operations are worthless, they are increasingly troubled. Here's what's going on, and what the miner is trying to do about it.
The dustbin of history
The example of cars destroying the buggy whip industry is an easy go-to when explaining the business impact of change and innovation over time. Today, coal is facing similar headwinds from cleaner alternatives, including natural gas, solar, and wind. There are still industries, notably steelmaking, that make heavy use of coal, and will likely continue to do so for a long time. But energy is really the big driver for most coal miners. And coal's place in that sector is shrinking.
That has resulted in a steady downturn in demand for the fuel that's helped to push several big names into bankruptcy court, including industry giant Peabody Energy (NYSE:BTU). In the face of massive headwinds, Alliance Resources has actually managed to perform relatively well. For starters, it hasn't taken a trip through bankruptcy court. But the master limited partnership also remained profitable in the decade that ended in 2019, generating enough cash to keep paying a distribution while others were talking to bankruptcy court judges.
Being the cleanest dirty shirt, however, only gets you so far on Wall Street. The stock is down 70% over the past year, nearly 90% over the past decade, and nearly 95% from the highs it reached in 2014. While coal isn't going away tomorrow, the writing is clearly on the wall, and investors are showing just how worried they are about Alliance's future. The third quarter was a demonstration of just how real the threat is and, notably, what the partnership is trying to do about it.
The number to watch
Putting its best foot forward, Alliance highlighted that third-quarter revenue advanced nearly 40%, net income jumped 158%, and EBITDA rose 146%. That's great on the surface -- until you consider that it was a sequential increase over the second quarter, which was hit hard by COVID-19. Essentially, it was a recovery from the early-pandemic lows. If you look at the year-over-year results for the third quarter, the numbers are far less inspiring: Sales, net income, and EBITDA were down by 23%, 30%, and about 3.5%, respectively. In other words, the big-picture coal headwinds are still there.
However, within those numbers is an interesting data point. The partnership's oil and natural gas division had a nearly 14% sequential increase in production compared to the second quarter, and a year-over-year increase of 8% compared to the same part of 2019. To be fair, that's a mixed blessing right now, because oil and natural gas prices are painfully low. The company's realized price for oil fell nearly 36% year-over-year, so this segment didn't have a good quarter on the profit front. However, the production numbers show that the partnership is clearly still investing in the business.
That makes logical sense, since natural gas is the primary fuel that's displacing coal. Natural gas, which burns more cleanly than coal, is widely expected to aid the transition from carbon fuels to clean energy. The problem is that this business is still very small, accounting for less than 10% of Alliance's adjusted EBITDA. The goal has been to use the cash generated on the coal side to fund growth on the oil and gas side, but that plan looks like it is getting more and more tenuous as coal's fortunes continue to sour. Still, if you own Alliance, you'll want to keep a close eye on the still-small oil and gas business.
How much time is left?
Alliance stopped paying distributions in February to preserve cash in the face of COVID-19, and long-term debt makes up a fairly conservative 35% of the partnership's capital structure. Although 2020 has been particularly tough, this generally conservative miner has long managed to navigate a declining industry better than its peers. Indeed, there's probably no need to fear for the partnership's near-term survival.
However, the long term here is another issue. While Alliance has set its sights on diversifying into the fuel that is replacing coal, it has been a slow-moving effort. And how much time remains is increasingly uncertain. Being one of the best-run coal miners isn't enough anymore. Alliance needs to show investors it can be more than that, and it needs to do it faster than it has been. At this point, with no distribution, most investors will probably want to avoid Alliance.