Peabody Energy (NYSE:BTU) is an international coal giant with operations on both sides of the globe. Alliance Resource Partners (NASDAQ:ARLP) is tiny in comparison, and basically works out of just one region of the United States. Why is Peabody struggling so much, while Alliance is thriving?
The big boy
When it comes to coal mining, Peabody is the largest pure-play miner around, with giant mines in several U.S. coal regions and in Australia. At one point, it was considered a rock-solid company, but not anymore. In fact, as some of the largest U.S. coal miners succumb to bankruptcy, there are increasing concerns that Peabody might be forced to go that route, as well.
The fact that it's lost money for three straight years is one reason. But the real backdrop is the weak coal market domestically and abroad. Indeed, coal of all types and in all regions has been lumbering along at painfully low prices. That's put the squeeze on profitability because coal mines are expensive to run.
What about Alliance?
But then there's Alliance, a much smaller miner that primarily works out of the Illinois Basin in the U.S. market. Alliance has seen its earnings go up in each of the last three years despite weak coal prices. What gives?
For starters, Illinois Basin coal has seen increased demand based on the particular kind of coal it produces. That's a big issue because it's allowed Alliance to increase production as the Illinois Basin steals market share from other coal regions. Thus, Alliance has been able to increase production to offset price declines.
That has a big impact on results. For example, Peabody's coal volumes fell 8.5% year over year in the first half of 2015. Alliance, on the other hand, saw sales volume increase by half a percent. That's a nine percentage point difference. And that's just the latest period -- this trend isn't new.
Falling sales volumes not only take a bite out of the top line, but they also impact costs. Generally speaking, the more a mine produces, the lower the cost per ton of coal mined. No wonder Peabody has been struggling with red ink while Alliance has been a model of profitability.
But that brings up another important point. Alliance's operations are more profitable, so it's making more per ton of coal sold. Although this is a big-picture look, Peabody's gross margin was around 18% last year, while Alliance's stood around 38%.
Gross margin is basically looking at revenues (coal sales) and the direct costs (mining expenses) to produce those revenues, so it doesn't take into consideration all of the other expenses a company faces, like taxes and selling, general, and administrative costs, among others. But it shows that Alliance has a lot more room to handle adversity.
Peabody's gross margin has been falling steadily for three years, while Alliance has seen its gross margin improve during the same span. Alliance's production increases are a big part of that. But so is its regional focus.
Generally, diversification is seen as a good thing. But in this case, Peabody's diversification is part of the problem. That's because it has exposure to domestic and foreign coal regions that aren't doing as well as the Illinois Basin and metallurgical coal.
Met coal, which is used in steel making, is usually a high-margin product -- but not right now. And that's part of the reason why Peabody's gross margin is taking such a hit. Indeed, as recently as 2011, its gross margin was as high as 30%.
Forget the giant, buy the minnow?
Peabody produced about five times as much coal as Alliance in the second quarter. But bigger isn't better in this case. If you're looking at the out-of-favor coal sector trying to find a survivor, you'd be better off going with Alliance. Sure, Peabody may make it through without a trip through bankruptcy court; but right now, that's not a risk I'd want to take on.