Alliance Resource Partners, L.P.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Alliance Resource Partners, L.P. (ARLP) is a diversified natural resources company that primarily produces and markets coal, and also generates royalty income from oil and gas mineral interests, with a focus on serving domestic and international utilities and industrial customers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

ARLP’s core business revolves around coal mining and marketing, with operations spread across several key regions including Illinois, Appalachia, and the Oil and Gas Royalty segment.

Business Overview

ARLP is a master limited partnership engaged in the production and marketing of coal primarily to major utilities and industrial users. It also generates royalty income from its oil and gas mineral interests, representing a significant though more variable revenue stream.

  • Coal Operations: ARLP’s coal operations are diverse, spanning across three major regions. The Illinois Basin operations represent their lowest cost and most advanced operations, while Appalachia remains the legacy operations, producing both thermal and metallurgical coal.
  • Oil & Gas Royalties: The oil and gas royalty division provides exposure to the pricing trends of oil and gas without the operational overhead involved in these markets. This segment receives royalty revenues rather than direct participation in production.

Industry Trends

  • The coal industry is facing a slow decline in the long term as renewable energy sources become increasingly competitive and government policies globally are encouraging a transition away from coal. This is particularly true in the United States and Europe.
  • However, in the near term, coal prices have seen significant volatility due to various factors, including supply disruptions, unexpected increases in demand, and geopolitical instability. This volatility presents both opportunities and challenges for coal producers.
  • The oil and gas sector is marked by increased prices and volatility due to supply constraints and international instability.

Competitive Landscape

  • ARLP competes with a variety of coal producers, both in the U.S. and internationally, each having unique cost structures, quality, and supply agreements with their customers.
  • The energy sector as a whole is in constant evolution, and ARLP competes against other energy sources, including natural gas and renewable technologies that are receiving increasing political and economic support.
  • ARLP differentiates itself through its scale, production capacity, and long-term supply agreements with large customers. However, these factors do not form a durable moat, as they are replicable and not that different from peers.

What Makes ARLP Different

  • Geographic Diversification: ARLP operates across several regions, including the Illinois Basin and Appalachia, that each present different advantages in production costs and sales strategies, as well as different transportation networks, which can provide more stability compared to other coal companies that are only based in one area.
  • Combined Operations: By combining its coal operations with a royalty-generating oil and gas business, the company is able to capture revenue streams of these two different industries.
  • Scale of Operations: Given that ARLP is one of the largest producers of coal in the US, they are well positioned to leverage their economics of scale and provide security of supply to their large customers.
  • Strategic Partnerships: The company has developed long-term relationships with customers, which provides stability to earnings.

Financial Analysis

ARLP’s financial performance has been influenced by market volatility. Recent performance has shown solid revenue generation but fluctuating expenses, requiring active management on profitability.

  • Revenue Distribution: The bulk of ARLP’s revenue is attributed to its Coal Operations. The Oil and Gas Royalty segments are comparatively smaller but more stable.
  • Margins: Profit margins vary significantly depending on the business unit. Coal operations are often pressured because of higher costs and lower prices, while royalty revenue provides higher margins. The company’s focus on profitability and cost efficiency is of great importance.
  • Financial Leverage: ARLP uses leverage to support its operations and expansion, so it is important to review the metrics regarding interest payments and solvency.

Latest Financial Information

  • Strong Operating Performance: Q3 2023 Earnings calls showed strong operational performance across most of its segments.
  • Production and Sales: Despite challenges in the industry, coal production volumes have been stable while coal sales have increased over the past quarters. Management has made a point that while they have made small adjustments to their 2023 production targets, they feel they will achieve those volumes.
  • Cost Inflation: The price of certain supplies has caused some inflation in the company’s costs and impacted their margins, a headwind the management has recognized and is trying to tackle.
  • Strong Guidance: For 2024, management is predicting an increase in royalties of 40% versus the prior year due to increased prices in the oil and gas market, alongside increasing capital expenditure on both operations. They feel bullish that these steps will bring significant improvements to the bottom line.

Moat Rating: 2 / 5

  • Explanation: ARLP has some minor advantages in terms of being a scaled producer with long-term customer relationships. Its integrated operations across multiple basins and its royalty segment also provide a slight edge. But these factors alone are not durable competitive advantages, because rivals can replicate or find new ways to combat these aspects, and due to the overall long term secular decline of the coal industry the business will be more challenged in keeping its market share intact and maintaining higher ROIC values.
  • Intangible Assets: While ARLP does not rely much on brands or other intangible assets, their operational knowledge and long-lasting customer relationships do provide them with a modest advantage.
  • Switching Costs: While there are no considerable switching costs for coal buyers, it could be argued that long-term contracts with the company provides some lock-in and predictability to customers.
  • Network Effect: ARLP does not have any network advantages.
  • Cost Advantages: ARLP does operate in the lowest-cost basins for coal production, which does provide them with some cost advantages compared to higher cost peers, but this advantage can be replicated or surpassed by new technologies.
  • Size Advantage: While ARLP has an important size, that doesn’t necessarily translate into a wide moat. Although it’s an advantage in cost, it doesn’t provide enough protection for their returns on capital.

Risks to the Moat & Business Resilience

  • Regulatory risk: Changing government regulations and stricter environmental laws could significantly increase operating costs, and can potentially limit the production of coal, while also reducing its demand.
  • Commodity risk: Volatility in commodity prices (coal, oil, and gas) will greatly impact revenues and profitability. The reliance on fossil fuels in the energy market also adds further volatility as this market shifts due to political or social policies.
  • Economic Downturn: Slow economic growth could limit demand for energy, which would lower both revenue and profitability of ARLP’s operations.
  • Credit Risk and Interest Payments: ARLP has quite a lot of debt. Changes in interest rates, and especially when coupled with economic downturns may negatively affect their ability to repay loans, while increasing financing expenses. This increases the credit risk of the company.

  • Technological Disruption: Technological advancements, notably in renewable energy, could lead to substantial declines in demand for fossil fuels.

  • Management Response to Risks: The management has stated in the last earnings calls, that they feel prepared to take on the challenges of an ever-changing industry, with cost-efficient methods and the focus on growth in non-coal revenue opportunities. But, if things turn worse for the coal sector in the near future or if new regulations make coal a liability the company’s resilience is limited. They do not show any significant long term plan to diversify operations.
    • The long-term prospects of ARLP’s business are quite volatile since they are heavily dependent on macroeconomic and political environments and, most importantly, on policies regarding coal and fossil fuels.

Understandability: 3 / 5

  • The business model is not particularly complex (selling coal and earning royalties from natural resources). But understanding the underlying factors which drive commodity prices and the impact of economic and political pressures in the long term can prove a difficult task for most investors, especially because the management doesn’t provide detailed forward-looking statements. It is not that complex, but requires a considerable understanding of the coal and energy markets.

Balance Sheet Health: 4 / 5

  • ARLP has a reasonable financial health, showing positive operating income and net income over the past years. Total debt is elevated, but manageable considering the companies’ overall assets and the high cash-generating capabilities. The company has also been focusing on reducing their debts. Their equity position has improved in the latest report, indicating improved shareholder value. Current ratios also are good.
  • However, the company needs to keep a good eye on its finances since its debt obligations are relatively high and should manage its finances adequately to stay liquid during adverse market conditions.

This analysis was created using multiple sources, including but not limited to: the company’s latest and prior 10-Q and 10-K reports, earnings call transcripts and press releases.