According to the U.S. Energy Information Administration, or EIA, coal is expected to be a major part of the U.S. power grid for decades to come. That's at odds with the environmentalist's view that renewable power will displace it. This dichotomy between public opinion and the EIA's projections is opening up an opportunity for intrepid income investors that will only get better if the stock market crashes.
Out of favor
To be fair, there are oversupply and demand issues in the coal space. But it's a commodity, and that's just part of the typical cycle.
The environmental backlash against carbon dioxide is simply raising the tension of this cyclical downturn. However, coal makes up around a third of the U.S. power supply. That can't be replaced overnight and, in fact, is expected to stay about the same for the next 25 years or so, according to the EIA.
If you're willing to take the contrarian view, coal stocks look like they're on sale now. But if the market crashes, they are likely to get even cheaper. You should keep an eye on dividend payers Peabody Energy Corporation (NYSE:BTU), Alliance Resource Partners, LP (NASDAQ:ARLP), and newcomer Foresight Energy LP (NYSE: FELP) for even better buying opportunities.
Peabody Energy is among the largest coal companies in the world. Unlike most large U.S. coal players, like Arch Coal (NASDAQOTH:ACIIQ) or Alpha Natural Resources (NASDAQOTH:ANRZQ), Peabody has a global mining footprint. Peabody's Australian mines accounted for roughly 40% of its revenues in the third quarter. The main destination for Australian coal is Asia, where coal demand is expected to continue growing.
Thus, through the purchase of Peabody, which was recently yielding around 3%, you get exposure to key U.S. coal regions, like the ultra-cheap Powder River Basin and the increasingly in demand Illinois Basin. You also get a foothold in a part of the world that's growing its power sector because of expanding urban populations and rising living standards. With operations in Australia, Peabody is better situated to serve that demand than U.S.-bound competitors.
Illinois is the place to be
For those who prefer a closer-to-home option, Alliance Resource Partners has been an industry standout during this downturn. In fact, since June 2012, Alliance is up more than 50%, while competitors are down between 50% (Peabody Energy) and 80% (Alpha Natural Resources). Why? Because it's almost totally focused on the Illinois Basin (ILB) region.
The combination of environmental regulations and technology have made ILB coal increasingly more desirable than nearby Central Appalachian, or CAPP, varieties. Thus, ILB coal is displacing CAPP coal. So while competitors have seen coal volumes fall, 2013 was the 13th year of record-breaking sales for Alliance. This year looks like it will extend the streak to 14 years.
Volume gains are basically making up for price weakness, but that doesn't diminish Alliance's solid position in the industry. And with a yield of around 5.9%, any big drop in the market could make this already high-yielding limited partnership even more desirable for income investors. Note, too, that Alliance has increased its dividend for 25 consecutive quarters.
That said, Alliance's story is already well known on Wall Street. The story of Foresight Energy, which recently had its IPO, isn't. And that's led to a disconnect between its ILB focus and its unit price. This limited partnership's units are below their IPO price, and the distribution on financial websites is listed at just $0.12 a year based on a $0.03-a-share distribution for just a part of the second quarter. That equates to a paltry yield of less than 1%.
The expected annual distribution, however, is $1.37 a year, leading to a yield closer to 7.8%. And, like Alliance, Foresight is posting record results because of is ILB focus. Similar partnership; much higher yield. If the market cracks, that yield will likely get even better -- despite the fact that Foresight has almost the same business model as current industry leader Alliance.
It's hard to go against the herd. However, if the market crashes, taking that risk with coal players Peabody, Alliance, and Foresight will get a little easier because you're likely to get paid even more via distributions from these already high yielders. If you can stomach being out of synch with public opinion, these three could turn out to be rewarding long-term investments.
Reuben Brewer has a position in Foresight Energy. The Motley Fool recommends Alliance Resource Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.