Master Limited Partnership Alliance Resource Partners, L.P. (NASDAQ:ARLP) is down 12% from its recent high unit price of $78.5. At today’s price of about $68, the units are yielding 6.6%, which is superb for a coal producer. Superb that is, if the distribution is not at risk of being cut. Not only is Alliance Resource Partners, L.P. (NASDAQ:ARLP)’s distribution safe, it has risen at a compound annual growth rate of 15% since 2003!
The distribution has increased by an annualized 12.5% over the past three years, arguably the worst period for coal producers in decades. Assuming that Alliance Resource Partners, L.P. (NASDAQ:ARLP)’s distribution rises at a reduced 9% a year for the next two years, the annualized distribution would climb from $4.52 to $5.37 per unit.
Range of Two-Year Total Returns Looks Compelling
The implied unit prices in two years at assumed distribution yields of 5.5%, 6.0%, 6.5%, 7.0% and 7.5% are $97.6, $89.5, $82.6, $76.7 and $71.6, respectively. At those unit prices, the total two-year return (including two years of distributions) would be 59.5%, 47.5%, 37%, 28.5% and 21%, respectively. This analysis assumes that distribution growth after two years remains near 9%. These prospective two-year returns are in line with the 10-yr annualized return from 2003 of about 25%.
Don’t Look to Coal Producers for Yield…
Investors don’t typically rely on yield when investing in coal producers, and for good reason. Until 2012, yields on coal names maxed out at about 2%. Today, there are higher yields to be had. For example, Walter Energy, Inc. (NYSE:WLT) has a 4.4% yield, but its dividend is far from safe. Walter Energy, Inc. (NYSE:WLT) last raised its quarterly dividend from $0.10 to $0.125 in May, 2010. Back then, with the stock at $77 per share, the yield was 0.65%.
Canadian company Teck Resources Ltd (USA) (NYSE:TCK) has a current yield of 4.2%. Teck Resources Ltd (USA) (NYSE:TCK) doubled its semi-annual dividend from June 2010 to December 2011 to an annual yield of about 2% at that time. Teck is the second largest premium hard coking coal producer in the world. While coking coal prices are quite depressed, the company also produces copper, which has held up better.
Cliffs Natural Resources Inc (NYSE:CLF) has a 3.7% yield. Interestingly, had Cliffs Natural Resources Inc (NYSE:CLF) not cut its dividend by 76% in November 2012 its stock would be yielding 15.4% today. Cliffs is under a lot of pressure to maintain its recently slashed dividend.
Alliance Has it All: Yield, Margins, Growth…
Not only does Alliance Resource Partners, L.P. (NASDAQ:ARLP) have by far the highest yield of any coal producer, it also happens to have the strongest financial metrics. It has production growth, (peers are shrinking), the best margins, the lowest debt leverage and operates in the two best situated coal regions. By prudently contracting coal sales far into the future, Alliance Resource Partners, L.P. (NASDAQ:ARLP) is now less exposed to the plunge in coal prices over the past 12-18 months.
While peers are cutting back production and suffering greatly from lower pricing and higher unit costs, Alliance Resource Partners, L.P. (NASDAQ:ARLP)’s contracting strategy gives it good visibility well into 2015. That is why Alliance is increasing production this year and possibly next. In addition, since it operates in the most attractive coal basins, it’s building new mines with the newest and most efficient technologies.
Conclusion
Next year could hardly be worse for coal producers, but moderate improvement may not be enough to turn companies like Walter Energy, Inc. (NYSE:WLT), Teck, Alpha Natural Resources, Inc. (NYSE:ANR) and Arch Coal Inc (NYSE:ACI) around. These companies will likely survive, but could be zombies for a long time. Alliance Resources Partners offers a far superior proposition: a robustly growing distribution on an already high current yield of 6.6%, with the possibility of significant capital appreciation.
The article Buy This Coal Producer Yielding 6.7% With 47% Upside originally appeared on Fool.com and is written by Peter Epstein.
Peter Epstein owns units of Alliance Resource Partners, L.P.. The Motley Fool recommends Alliance Resource Partners, L.P.. Peter is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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