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A California state senator might propose a bill in January that would require the California Public Employees’ Retirement System to divest of its holdings in companies that produce coal. This headline-grabbing news sent coal stocks and ARLP partners down significantly. However, Peter Epstein thinks that the reaction was possibly overdone.
By Peter Epstein
On December 15, news outlets announced that a California state senator might propose a bill in January that would require the California Public Employees’ Retirement System (CALPERS) to divest of its holdings in companies that produce coal. According to a Bloomberg article, CALPERS has $5.2 million worth of coal master limited partnership Alliance Resource Partners (NASDAQ:ARLP).
At the current unit price of ARLP, the average trading volume would cover CALPERS’ $5.2-million holding in a single day. More likely, CALPERS would dispose of those shares over the course of a week or two. This headline-grabbing news sent coal stocks and ARLP partners down significantly on December 15. However, I think that the reaction on ARLP was possibly overdone.
ARLP in a league of its own
ARLP is a coal producer in the Illinois and Northern Appalachian coal basins. ARLP is unique in three very important ways. First, it is largely contracted and has priced its coal requirements for 2015 and even for a high proportion of 2016. Second, the company is located in the two best coal basins in the country. Third, it has a strong balance sheet and industry-leading margins. ARLP has a very strong record of performance, which has enabled it to increase its unit distribution each and every quarter for the past 10 years.
Recently, ARLP reiterated its performance guidance for 2014. This performance, if achieved, would be a very solid result, especially vs. peers such as Peabody Energy (NYSE:BTU), Arch Coal (NYSE:ACI), Walter Energy (NYSE:WLT) and Alpha Natural Resources (NYSE:ANR). ARLP carries a debt load of about $1 billion on top of a market cap of $3 billion. Peers are much more debt challenged. For example, Walter is weighed down by $3.2 billion on top of a market cap of just $115 million. That’s why some of Walter’s unsecured bonds are trading at 25 to 35 cents on the dollar. That implies zero recovery for stock holders.
Coal-producing peers have self-inflicted wounds from top-of-the-market acquisitions
While the peers of ARLP mentioned above loaded up with debt-fueled acquisitions in 2011 (the top of the market), ARLP stuck its knitting and didn’t chase after coal assets at inflated prices. Walter Energy acquired a Canadian coal company with high-cost mines plagued with operating issues. Walter’s Canadian assets are currently on care and maintenance. Alpha Natural Resources acquired troubled Massey Energy, a company still reeling from a terrible mining accident involving fatalities. Arch Coal took over an East Coast coal producer that boasted a large coking coal mine, the problem being that the mine was still three years from production and required hundreds of millions of capital to complete. Peabody Energy, the former leader of the coal pack, acquired an Australian company that produced a niche coal product. Prices for that niche product have since fallen by an incredible amount.
In fact, just looking at the coking coal landscape tells quite a story. Importantly, ARLP does not traffic in coking coal, the coal used to make steel. Instead, ARLP is entirely thermal coal used to generate electricity. Make no mistake, coal prices of both varieties are down significantly. For example, the benchmark quarterly coking coal price for the best-quality coking coal is down from $330 per tonne in mid-2011 (when Arch, Peabody, Walter and Alpha were making ill-fated acquisitions) to a current price of $117 per tonne. That’s a decline of roughly 65 percent. The outlook for coking coal over the coming quarters isn’t calling for prices to get much better than the currently depressed $117 per tonne mark.
Conclusion
Therefore, in my opinion, ARLP is in a league of its own in the coal space. Importantly, the current yield of the units is a solid 6.6 percent. I believe that ARLP will at the very least maintain its quarterly unit distribution, but will more likely continue to increase its quarterly distribution as it has for many years in a row. This is only possible due to the company’s visibility as far as 2016 on contacted and priced thermal coal contracts. If this is indeed the case — that ARLP can indeed continue to increase its quarterly distribution per unit — then I believe that the company will also continue to outperform its coal producing peers.
In 2011, Peter Epstein, CFA, left a $3-billion hedge fund where he was a senior natural resources analyst to help increase awareness of a number of natural resource companies in which he’s invested in.
PLEASE FOLLOW ME ON TWITTER: @peterepstein2
Mr. Epstein formed MockingJay, Inc., a consultancy for companies in the natural resources space and informal (non-licensed) advisor to high-net-worth investors. Mr. Epstein’s areas of expertise include uranium, coal, gold, potash, oil and gas and graphite.
He has published hundreds of articles / blogs on investment sites such as Seeking Alpha, MyriadEquity.com, miningfeeds.com, the Motley Fool, InvestorIntel, Talkmarkets, Stockhouse, CEO.ca, Financial Press and Resource Investing News.
Mr. Epstein can be reached at epstein.peter4@gmail.com to discuss his highest-conviction ideas. Unless expressly noted, Mr. Epstein is not being paid by the companies that he writes about.