Alliance Resource Partners LP (ARLP 0.33%) is a U.S. coal producer, but its operating margins, organic growth and management skill in navigating an extremely difficult coal sector make this company stand out. Alliance split 2 for 1 earlier this week, bringing the unit price down to $45. The distribution yield is running at a generous 5.4%. Despite the constant string of negative headlines, including both real and perceived risks facing the coal industry (Obama's war on coal, EPA regulations, growth of renewables, etc), Alliance's operating performance has been spectacular.
To be clear, the company is excelling not just against peer companies like Peabody Energy (BTU +0.00%) but against other multi-billion dollar natural resource companies like Franco-Nevada (FNV +0.25%) and BHP Billiton (BHP +0.04%)
Before comparing Alliance to other companies, a quick overview: Although Alliance is a coal producer, one of the worst industries for investors over the past 2-3 years, its operating performance has been nothing short of superb. It's the third largest eastern coal producer with 38.8 million tons of thermal coal produced in 2013. It has very real and substantial asset value with 1.1 billion tons of coal reserves at December 31, 2013. Alliance also enjoys very low debt leverage with a 1.2x debt-to-EBITDA ratio.
By comparison, peer U.S. coal producers have tremendous debt burdens, with debt-to-EBITDA ratios averaging 7.0x and peer Energy MLP's average 3.9x. James River and Patriot Coal were forced into bankruptcy due to insurmountable debt levels.
How has Alliance thrived in an industry left for dead?
Alliance has operating metrics that are simply unheard of for the coal sector. For example, the company's EBITDA margin was already among the best in the sector in 2009 at 27.6%. Last year it was 31%! Peabody Energy's 2013 EBITDA margin was 12.8%, and it will be lower in 2014. Peabody has a debt-to-EBITDA ratio of 11.1x. At this point, I will stop comparing Alliance to debt-laden, low-margin U.S. coal producers. Most investors, understandably, don't want to touch the coal sector these days.
Even though Alliance is in the hated coal business, its operations are focused in the first and second best coal regions of the country -- the Illinois Basin and Northern Appalachia. The management team could not possibly have chosen better basins. These low-cost thermal coal regions have withstood the volatility of exports and coking coal pricing as well as being relatively unfazed by the collapse in natural gas prices of 2012-13. As a result, Alliance has grown its annual EBITDA at a 5-year CAGR of 17% from 2009 to 2014 (forecast). Again, this type of performance, all from internal growth and without excessive use of debt, is truly spectacular.
Distribution growth has averaged 11.1% over the past 20 quarters!
Looking back at the last 20 quarterly distributions, the average year-over-year growth rate has been 11.1%. Given the EBITDA growth of 17% over the same period, the distribution growth is not surprising, nor is the company stretching to pay out robust distributions. More recently, distribution growth has slowed to 8% year over year, but this is in a period of severely depressed coal prices. Importantly, the company has reinvested hundreds of millions of dollars into growth capex in 2010-2013 and will be reaping the benefits of those expenditures in 2015 and beyond.
Even maintaining 8% distribution growth as coal markets bottom and coal pricing improves will support strong demand for Alliance Resource Partners units. Finding high-yielding investments gets harder by the day. Telecom and utility stocks are yielding about 3%-4%, but offer more operating variability than the strong and stable performance of Alliance. Fixed income yields on short- and intermediate-duration investment grade corporate bonds are in the 2%-4% range, but fears of inflation make those alternatives risky as well. I believe that investors will continue to drive the unit price of Alliance higher until the distribution yield falls to 5%. A 5% yield would equate to a unit price of about $52, which is 15% above the current price. Therefore, capital appreciation plus current yield could provide a 20%-21% total return over the next year.
Why not buy a gold streamer or diversified natural resource company instead?
I've made multiple comparisons to peer coal companies, but investors don't have to invest in coal; what about gold, iron ore, or oil and gas? Two companies mentioned above, Franco-Nevada and BHP Billiton offer interesting comparisons to Alliance Natural Resources. Both Franco and BHP Billiton are industry leaders and are relatively low-risk investments. For example, Franco-Nevada's business model is to collect decades'-long royalty payments from gold companies that it lends to. This royalty model is well established and well liked by investors. Yet, Franco-Nevada's dividend yield is just 1.6%, and it trades at an EV-to-EBITDA ratio of 21x vs Alliance at just 5x. Franco-Nevada has much stronger EBITDA margins than Alliance due to its low-risk royalty model, but the valuation seems to fully reflect that.
BHP Billiton is an absolute giant with a market cap in the hundreds of billions of dollars. It is a truly diversified natural resource player with coking coal comprising only about 20% of its operations. It also has a top three iron ore business and is one of the largest oil and gas producers. BHP Billiton has a dividend yield of 3.5% and trades at a premium valuation to Alliance. BHP Billiton's dividend is not expected to grow anywhere near 8% per year.
Bottom line
Alliance Resource Partners LP is a coal producer, which is perhaps a non-starter for some. Looking beyond that fact, the company is actually a cash-flowing, distribution-paying machine with annual growth in distributions in the 8% range highly likely (in my opinion). Performance has been so strong and steady, without the overuse of debt, that I believe visibility for robust earnings and cash flow over the next two years is quite good. The chances of a total return of 20%-21% over the next year is also quite good. This best-in-class MLP offers both capital appreciation and a solid yield. Investors should take a close look at making Alliance a part of their investment portfolio.
