So far in 2015, pretty much all the media attention for the energy space has gone to the decline in oil prices. If you want to see an industry that is suffering even more than oil, though, you need to look at coal. So far this year, we have seen one of the three largest U.S. coal producers file Chapter 11 bankruptcy and a few others appear to be close to collapse themselves. Despite this extremely challenging market, however, one company has been able to perform well: Alliance Resource Partners (NASDAQ:ARLP).
One thing that investors could point to as a sign of success is how management has handled the company over the years. With that in mind, it's probably worth paying attention when management has something to say about the business or the coal market. So here are five key quotes from Alliance management and that of its general partner, Alliance Holdings GP (NASDAQ:AHGP), on its most recent conference call.
There is only one certainty in the coal market right now, and it is that is completely uncertain. Continued pressure from cheap natural gas has kept demand and, in turn, prices low. At the same time, though, there are a slew of miners that have either gone bankrupt or are on the brink that could bring a bit of supply out of the market. Because of this, Alliance's management is taking a wait-and-see approach before giving any sort of outlook in terms of production.
According to CEO Joseph Craft:
As we assess the short-term outlook for the industry, we expect 2016 domestic thermal demand to be comparable to 2015. However, we anticipate export shipments will be lower and natural gas prices will remain low, which will continue to pressure coal prices until there is a supply response. Combining lower market prices with the short-term buying strategy being followed by many of our customers is requiring us to constantly determine the appropriate production levels for our installed capacity.
Taking a cautious approach
For a company to pay such a generous distribution like Alliance, there needs to be some clarity when it comes to cash flows. Since the company said it doesn't have the clarity it wants, it has decided to not commit to any increased outflows in spending, including any increases to its distribution. As Craft said:
It is this short-term uncertainty that led our board to elect to maintain quarterly cash distributions at current levels. We have always managed the Alliance partnerships with the goal of creating long-term value for our unitholders through developing low-cost, strategically located operations in the Illinois Basin and Northern Appalachian regions, building strong customer relationships and maintaining a conservative balance sheet. We believe this is -- this proactive decision to maintain distributions at current levels until we know our production volumes will have predictable sustainable growth is in keeping with this objective in a prudent step in light of the uncertainty facing our industry.
The company's payout isn't in any for sort of danger right now. Its distribution coverage ratio for the most recent quarter was 1.66 times, which means there is more than enough cash coming in the door to pay the distribution and have some left over to reinvest in the business. This appears to be a very cautious move, which, considering the state of the coal market, is a smart thing to do.
Diversifying from coal
One thing that has hurt so many other coal companies was that they didn't diversify their revenue streams when they had the financial flexibility to do so. Alliance doesn't want to make that same mistake, so according CFO Brian Cantrell, the company is stepping up its investments outside the coal space:
ARLP recently elected to increase its commitment to acquire oil and gas mineral interest by an additional $100 million over the next 2 years, bringing our total commitment to this activity to approximately $150 million. We currently expect to fund approximately $45 million to $55 million of this total commitment in 2015, which, when combined with the $50 million cash payment for White Oak equity upon closing of the acquisition and the $10.8 million in preferred equity contributions funded for White Oak prior to closing, will result in total investment funding this year of approximately $105 million to $115 million.
Let's be clear here: $150 million in oil and gas investments isn't that much compared to the $2.3 billion in coal revenue it pulled in over the past 12 months. This isn't a game-changing sort of investment in and of itself, but if management were to continue to build a position in other oil and gas mineral rights over the next couple of years, it could become something noteworthy.
Finding more ways to cut costs
Alliance has been one of the lower-cost producers in the coal industry for some time now, which has allowed it to be profitable and grow market share while so many others have been floundering. While the location of its assets has been a major advantage, another has been management's moves to control costs. With so many other companies struggling and shuttering mines, Alliance is using it as an opportunity to buy mining equipment on the cheap. As Craft pointed out:
There is plenty of surplus equipment in the market. We look at our own operation -- that is [indiscernible] depleting either at end of the year or the first quarter 2016. So that frees up some equipment we still kept -- we purchased from the Patriot transaction. It's assisting us in our capital as we look -- as we go in. So I believe that our CapEx number will be coming down from what you've seen, maintain their maintenance capital at the same number we had last quarter.
This is one of those clever things a company can do for a time, but they aren't exactly permanent savings the company can realize year in, year out. Eventually, Alliance will need to spring for new equipment, but hopefully the market will have improved by then.
Will take advantage of other companies' weakness
The market for coal, like those of every other commodity, is cyclical. Sure, there is a lot of pressure on demand, but that just means there will need to be a supply response. When that does happen, Alliance's management sees a time where it can capture even greater market share while others try to recover from their bloated balance sheets. According to Craft:
One, we believe that this current situation is temporary, so we don't believe -- I mean, we believe that the supply and demand will, in fact, come in balance. Prices will improve, and we also believe that as we look at the mine plans of our competitors, we know that there are mines that are depleting over the next 2 to 3 years. And the question will be, will those competitors decide to bring capital in to maintain that production or not. We're at the view that with the excess capacity in the basin, they will not. And if it does, we are a low-cost producer, we have a very good opportunity to grow our production once we get back a supply demand balance.
Coal may not be the dominant energy supplier it once was, and the argument can be made that we are in a time where coal demand is in structural and perpetual decline. However, that is still a ways off, and the weakness of so many other coal companies today gives Alliance plenty of room to be a growing, profitable company for a few years to come.