What to Expect From Alliance Resource Partners, L.P. in 2018

A coal miner working in a coal mine

The domestic coal industry will continue to face headwinds in 2018, but that's not a new development. So, yet again, Alliance Resource Partners, L.P. (NASDAQ: ARLP) is facing a year that will test its management team. However, based on the partnership's past success, I think investors should expect another solid year from Alliance Resource Partners in 2018. Here's what to watch.

The commodity impact

There's no way around the basics of the coal industry: It's a commodity and prices go up and down with demand. So we can't predict exactly how good (or bad) prices will be for Alliance's thermal coal as we enter 2018.

There's also the complication that coal increasingly competes with natural gas for market share. However, the arctic blast that hit much of the country in the early days of 2018 has materially increased demand for natural gas, pushing prices notably higher in select regions. That should benefit coal, at least a little bit. But the long-term benefit is debatable, as the weather is even more variable than commodity prices.

So as you look at 2018 and consider Alliance's prospects, you'll want to keep coal prices in mind. But you shouldn't let that be the main factor in your expectations. There are other facts that you'll want to consider.

The core of Alliance's business

For example, at the end of the third quarter Alliance had customer commitments for 23.1 million tons of coal in 2018. It expects to sell around 38 million tones in 2017, so at last count it had about 60% of its 2018 sales locked in. This is a shift from years past when utilities tended to sign contracts well in advance. Today the approach is to do more short-term deals. So 60% isn't a bad number. I expect the fourth-quarter update to push the committed sales number higher.

The real takeaway, however, is that demand for Alliance's coal is still there despite the dire news about the death of coal. And the cold in the first few days of the year should actually be a net benefit, assuming utilities burn additional coal from their stockpiles that they then must replace. The reasonable expectation is that Alliance will sell roughly the same amount of coal in 2018 as it did in 2017.

Realizing that coal is facing headwinds, Alliance has been working hard to control costs. Through the first nine months of 2017 it was able to trim operating expenses by 5.4%, largely by shifting production to its lowest-cost facilities. That suggests that costs will remain relatively low in 2018. However, further cost reductions are likely to be harder to achieve from here. So, like production, I would expect expenses to stick at around the levels of 2017, too.

What I don't think will change is Alliance's rock-solid balance sheet . Long-term debt makes up around 25% of the partnership's capital structure. Interest expense, meanwhile, ate up a modest 6.5% of earnings before interest, taxes, depreciation, and amortization ( EBITDA). In other words, Alliance's financial foundation remains strong. There should be no questions about the ability of this coal miner to survive as 2018 progresses. That's an important issue in an industry that's seen multiple big-name bankruptcies over the past few years.

So far it sounds like 2018 will be the same old, same old for Alliance. That's largely true and exactly what you want to see from a coal miner, in my opinion. However, management has expressed confidence in its ability to keep raising the distribution. It restarted that trend in 2017, ending the year with two consecutive quarterly hikes. The current yield is an impressive 9.9%.

What to expect in 2018

Data source: Alliance Resource Partners, L.P.

Furthermore, in the third-quarter earnings release, management stated, "Considering our performance to date, conservative balance sheet and current expectations for attractive cash flows in the future, ARLP is positioned to continue increasing distributions to our unitholders on a quarterly basis." I think anything beyond one distribution increase in 2018 should be looked at as a sign of Alliance's continuing success at navigating a difficult market.

The one big change to watch is actually taking place at the edges. Alliance has increasingly been dipping its toes into the oil and gas space. That's gotten other partnerships into trouble as they venture outside of their comfort zone, most notably propane distributor Ferrellgas Partners, L.P. (NYSE: FGP) . That partnership's debt-fueled oil and gas midstream purchases didn't pan out , leaving it with a heavy debt load and idle assets. However, Alliance is taking a relatively slow approach to its diversification effort.

For example, although equity in interest of affiliates (where the income from its oil and gas investments shows up) more than tripled year over year in the third quarter, the $3.8 million figure pales in comparison to coal revenue of around $450 million. Alliance is a conservatively run partnership, so I would expect only incremental investments here. But keep an eye on its progress, because it hints at a shifting structure for the business.

The one wild card is Alliance Holdings GP, L.P. (NASDAQ: AHGP) , Alliance Resource Partners' general partner. Alliance Resource bought the incentive distribution rights from Alliance Holdings in 2017, hinting that it could buy its general partner at some date in the future. Over the long term, it would be a good move, helping to simplify the business. There's no way to tell when this might happen, but it would likely leave Alliance Holdings with more debt and/or a much higher unit count than it currently has.

Sum of the parts

When you add it all up, I expect 2018 to be another solid (though unspectacular) year for Alliance Resource Partners. I believe it will continue to do well in a difficult coal market, and will remain financially disciplined so that it can continue to reward unitholders with a hefty yield and distribution increases over time. Investments in the oil and natural gas sector will be increasingly important factors, but not so much so that they alter the business in 2018. In other words, I think 2018 will be a pretty good year considering the headwinds coal continues to face.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Alliance Resource Partners. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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