To suggest that the coal industry is out of favor is a massive understatement. The shares of industry giants like Peabody Energy (BTU) and Arch Coal (NYSE: ACI) are down 60% and 80%, respectively, over the past three years. However, Alliance Resource Partners (ARLP 1.51%) has seen its shares rise about 30% over that same span. Industry leading performance is why, and also why you should consider owning this 6% yielder.
Coal is unloved in the U.S. because it is one of the dirtiest fuel options available. That, plus relatively low natural gas prices, has led to a weak domestic thermal coal market. Globally, China's glutenous appetite for natural resources last decade led to a massive ramp up of both thermal and metallurgical coal supply. Now that China's growth is ebbing, supply is outstripping demand.
Diversified troubles
While that's a very brief overview of the problem, it helps explain why Peabody, with operations spanning the globe, is expecting third quarter earnings to be in the range of a loss of $0.16 a share and a profit of $0.09. And through the first six months of the year, the company only made $0.25 a share, compared to $1.39 last year. Peabody is struggling and it's one of the best positioned coal miners in the world.
Arch Coal has done even worse. It doesn't have the Australian operations that account for about half of Peabody's business, so it is less diversified. However, it operates both met and thermal coal mines in the states and ranks among the world's largest coal miners. It's lost money in four of the last five quarters. And it trimmed its 2013 production forecast after the second quarter, which suggests that the rest of the year isn't going to be much better.
Sector specific issues
Less diversified Walter Energy (WLTGQ), which focuses almost exclusively on metallurgical coal, has lost money in each of the last four quarters. And while Walter's management believes that met coal markets are starting to pick up, they are still at depressed levels. So, Walter is another miner unlikely to turn a profit in 2013.
Better off has been U.S. thermal player Cloud Peak Energy (CLD), which has remained profitable despite coal's troubles because of its ultra cheap Powder River Basin coal. That said, earnings fell to just $0.08 a share in the second quarter. Moreover, it expects 2013 shipments to be flat year over year because utilities still haven't increased their coal orders despite rising natural gas prices. Although the company will likely make money in 2013, these certainly aren't the company's halcyon days.
Low costs and the big shift
Low cost coal is why Cloud Peak has managed to hold up reasonably well. It's also why Alliance Resource Partners has been able to put up record results. Alliance gets most of its coal from the Illinois Basin (ILB), which is the second cheapest coal region in the country. Moreover, demand for ILB coal has been increasing in recent years as utilities shift away from higher cost regions.
To put that in perspective, the CEO of rail company CSX recently stated that ILB coal volume at his company more than doubled over the past three years, largely at the expense of Central Appalachian coal. That's allowed Alliance to expand its production at a time when others have been pulling back. Year over year, the partnership sold over 13% more coal in the second quarter.
That's a big jump and it more than offset the nearly 7% drop in coal prices the company experienced. Moreover, management is pretty upbeat about the second half: "Our performance to date and expectations for the remainder of 2013 allow us to increase full year guidance and give us confidence that ARLP will deliver its thirteenth consecutive year of record results." Clearly, the LP is worthy of consideration based on its performance.
Leveraged to the upside
That said, the share price advance versus the rest of the industry's price weakness might give you pause, but don't let it stop you. Alliance is selling more coal for less per ton. When supply and demand start to balance out, it will be selling more coal for more per ton—leveraging the profitable production growth it's achieved during the downturn.
Also, the partnership offers an impressive 6% yield. And it has increased the distribution at least annually for a decade, including a hike in the second quarter. True, Alliance lacks the upside potential of a Walter, where the share price has fallen 80% over the past three years. But investors are starting out with a 6% return from a distribution that has steadily increased. Even modest share price advances will provide a respectable total return.
If you pick apart the coal industry, there are a lot of things to worry about. Alliance, however, isn't one of them. This high-yielding industry leader is worth the risk of venturing into the troubled coal market.
