The nuclear emergency in Japan caused by the tsunami makes the governments around the world have a second thought about relying on nuclear power for their future power solution. Coal-powered plants, despite being labeled as generating a dirty form of energy, have found at least temporary new lives. So have the coal producers.
In the developed world, coal may be considered less desirable in the long term, but developing nations like China and India are building more coal-fired power plants, and these nations don't have enough coal to fuel the plants. Those nations have been buying coals from countries that used to ship steam coal to Europe. As a result, Europe turns to U.S. producers.
In the U.S., major coal producers include: Alliance Resource Partners (NASDAQ:ARLP) and its competitors such as Alpha Natural Resources (ANR), Peabody Energy (BTU), Consol Energy (NYSE:CNX), Oxford Resource Partners (OXF), and Cloud Peak Energy (NYSE:CLD).
Among them, Alliance Resource Partners (NASDAQ:ARLP) is a producer with a strong business predictability.
ARLP is a diversified producer and marketer of coal primarily to major United States utilities and industrial users. It began mining operations in 1971 and since then has grown through acquisitions and internal development to become the fourth-largest coal producer in the eastern United States.
On December 31, 2010, The company had approximately 697.4 million tons of coal reserves in Illinois, Indiana, Kentucky, Maryland, Pennsylvania and West Virginia. In 2010, it produced 28.9 million tons of coal and sold 30.3 million tons of coal.
As of December 31, 2010, the company operates nine underground mining complexes. It is constructing a new mining complex in West Virginia, and it also operates a coal loading terminal on the Ohio River at Mt. Vernon, Ind.
Its mining activities are conducted in three geographic regions commonly referred to in the coal industry as the Illinois Basin, Central Appalachian and Northern Appalachian regions.
The company has grown historically and expects to grow in the future through expansion of its operations by adding and developing mines and coal reserves in the regions it operates in.
Coal Marketing and Sales
As is customary in the coal industry, the company sells its coal by entering into long-term coal supply agreements with its customers. In 2010, approximately 92.4% and 89.0% of its sales tonnage and total coal sales, respectively, were sold under long-term contracts (contracts having a term of one year or greater), with a total revenue of $1.6 billion.
Over the years, ARLP has achieved steady growth in its revenue and EBITDA:
Revenue has grown 14.9% per year and EBITDA has grown 19.06% per year in the past decade.
The coal industry is intensely competitive. The most important factors on which the competitors compete are coal price, coal quality (including sulfur and heat content), transportation costs from the mine to the customer and the reliability of supply. The company’s principal competitors include Alpha Natural Resources (ANR), Peabody Energy (BTU), Consol Energy (NYSE:CNX), Oxford Resource Partners (OXF), and Cloud Peak Energy (NYSE:CLD) and many others.
Further, coal competes with other fuels such as petroleum, natural gas, nuclear energy and renewable energy sources for electrical power generation. Over time, costs and other factors, such as safety and environmental considerations, may affect the overall demand for coal as a fuel.
Below I compare the ARLP with some of its competitors:
|Market Value ($mil)||6,880||18,431||11,901||2,981||276.83||1,324|
|Operating Margin (%)||6.72||12.48||9.20||19.94||-1.51||4.32|
|Net Margin (%)||2.44||11.28||6.62||19.94||-2.06||2.46|
|Debt to Equity (%)||28||58||109||154||88||161|
It appears that Alliance Resource Partners has one of the lowest P/E among its competitors; it enjoys the healthiest ROA, ROE, Operating Margin and Net Margin. However, such a favorable matrix come from the highest debt-to-equity ratio among its chief competitors.
As a limited partnership, ARLP distributes cash to its unitholders without paying federal income tax. In the past decade, cash distribution has grown 15.9% per year and in 2010, the company paid $3.20 per unit to its unitholders.
I think using dividend payment instead of the volatile free cash flow is better in estimating the company’s intrinsic value.
Using the DCF calculator provided by GuruFocus, and assuming that the company can grow its dividend payment at the same rate in the coming decade; after 10 years, we assume a terminal growth rate of 4% and use a discount rate of 10%, we reached a fair value of $89.54.
Compared to the current $81.0, the stock does not present a good margin of safety.
Since March 11, Alliance Resource Partners stock price has rallied 12.43% under the newly found favoritism by the investors. As a result, the current stock price is about 10% below its intrinsic value. Stock price may still move higher, carried by upward momentum. Value investors, however, better consider what has been baked into the current stock price and think twice before committing capital to this stock.