There's a lot going on in the coal industry these days, not much of which is good news for investors. Coal is under intense pressure right now due to multiple factors. First, coal faces rising public and regulatory scrutiny for the environmental and public health effects of using coal. This puts coal's future in doubt, as it's likely the United States will see a major reduction in new coal-fired plants being built going forward. Separately, falling natural gas prices place an added headwind on coal, as industrial end users such as utilities are incentivized to switch from coal to cheap natural gas.
Add it all up, and this explains the rash of coal companies entering, or nearing, bankruptcy. But amid all of the panic, the truth is that coal remains an integral part of our power generation. After all, coal still accounts for approximately 40% of electricity generation in the United States. From this perspective, one could argue that coal is still a matter of national security.
But there are critical differences between the coal companies that are struggling, and one that is still doing well.
Many coal companies are in real danger
Last year, James River Coal filed for Chapter 11 bankruptcy. This year, Patriot Coal filed for Chapter 11 again, just 18 months after it emerged from its previous Chapter 11 filing.. Furthermore, Arch Coal (NYSE: ACI) recently began talks with advisors to restructure its large debt load. The company maintains it is not looking at bankruptcy, although that is far from certain. Because of the massive fall in the company's share price, it has received a notification from the New York Stock Exchange that it no longer satisfies the requirements to be listed on the NYSE.
This has occurred as a consequence of the company's crumbling business. Arch Coal lost $558 million in 2014, and lost $641 million the previous year. Such significant losses seriously impair the company's ability to satisfy its creditors. At the end of the first quarter 2015, Arch Coal held more than $5.1 billion in long-term debt, which is a huge concern given that the company continues to lose money.
Similarly, Alpha Natural Resources (NASDAQOTH:ANRZQ) is also bleeding. The company lost $875 million last year, which was only a modest improvement from the $1.1 billion loss the year before.
At its core, the problem for many coal companies is their geographic and product focus. Arch Coal, Alpha Natural, and the other struggling coal companies are major players in Appalachian coal and Powder River Basin coal. These regions have been the hardest hit by the emergence of cheap and abundant domestic natural gas. This was the key motivating factor behind Alpha Natural's recent closing of a mining facility in West Virginia.
There was some hope that coal exports would save the day, but metallurgical coal has suffered too. Exports are slowing to emerging markets such as China and Brazil, as their economic growth has leveled off. And, exports are growing from nations like Russia and Brazil, which is resulting in lower prices.
But this doesn't mean there aren't any coal companies getting it right. One coal company actually still doing well is Alliance Resource Partners LP (NASDAQ: ARLP).
The prettiest house in a very ugly neighborhood
I have believed for some time, and continue to believe, that Alliance Resource Partners remains the strongest publicly traded coal company. Amazingly, Alliance Resource set company records for coal sales, production volumes, revenues, net income, and EBITDA last year thanks to stronger pricing and lower expenses. In fact, Alliance has set company records for 14 years in a row. And, Alliance has a sound balance sheet. Its debt-to-EBITDA ratio is a very modest 1.1 times, while its industry peers are in the 3-4 times range.
Since it's structured as an MLP, it's required to pass along the majority of its cash flow through to its investors. This results in a very high 9% distribution, which is covered by operational cash flow. Alliance Resource has raised its distribution for 28 consecutive quarters, and over the past five years, it has increased its distribution by 10.8% per year, compounded annually.
The reason for Alliance Resource's unique success while so many other coal companies are collapsing is its advantageous business model. Alliance Resource is the low-cost operator in the business, which allows it to maintain profitability. Its coal mines are situated very close to its industrial end users, which leads to much lower costs. In addition, Alliance is a major player in Illinois Basin coal, where economics remain stable.
Alliance Resource is using the tough climate to its advantage. Earlier this year, Alliance Resource opportunistically scooped up 3.7 million tons of coal supply from Patriot Coal, to be delivered through 2017. In addition, some of Alliance Resource's affiliates purchased other assets from Patriot, including coal reserves and mining equipment.
Watch these coal stocks carefully
The bottom line is that it's obviously a brutal time for coal, but not all coal companies are getting crushed. Several coal companies have declared bankruptcy, and others may follow, but Alliance Resource Partners continues to display sound fundamentals and rewards its investors with a very high distribution. Its low-cost operation and critical geographic advantage are the reasons for its long track record of success.