Alliance Resource Partners, L.P.: Can a 12% Yield Possibly Be Safe?
If You Want to Earn a Double-Digit Yield, Read This
Risk-averse investors tend to stay away from ultra-high-yielding stocks, but you might want to make an exception for this one.
I’m talking about Alliance Resource Partners, L.P. (NASDAQ:ARLP), a master limited partnership (MLP) headquartered in Tulsa, Oklahoma.
The partnership does not make headlines often, but it deserves income investors’ attention for a very simple reason: the sheer size of its payout.
With a quarterly distribution rate of $0.525 per unit, ARLP stock offers a jaw-dropping yield of 12.1%.
Since we live in an era when the average S&P 500 company pays just over two percent, a yield surpassing the double-digit mark may simply seem too good to be true. In particular, a common reason why a company can offer an ultra-high yield is a drop in its share price. And the blunt reality is that most times, stocks tumble for a good reason. (Source: “S&P 500 Dividend Yield,” Multpl.com, last accessed January 3, 2018.)
As income investors, you don’t want to try catching a falling knife. If a company’s fundamentals are not sound, it would not be worth considering, no matter how high its yield is.
So why are we still looking at this ultra-high yielder?
Well, because, while ARLP stock hasn’t been a hot commodity, it still runs a solid business.
In fact, one of the main reasons why the partnership’s unit price tumbled was that sentiment changed towards its industry, coal.
ARLP Stock Is a Beaten-Down Stock with a Juicy Payout
You see, most MLPs are in the midstream oil and gas business, but Alliance Resource Partners, L.P. is a coal producer. The company started its mining operations in 1971 and has grown to become the second-largest coal producer in the eastern United States.
Today, the partnership has eight mining complexes in Illinois, Indiana, Kentucky, Maryland, and West Virginia—and a coal loading terminal at Mount Vernon, Indiana.
Over the years, Alliance Resource Partners has also made investments in oil and gas mineral interests, and in gas compression services. They provide the partnership with additional sources of income.
If you’ve been following the markets, you’d know that investors aren’t really enthusiastic about the coal industry these days. As a major producer and marketer of coal, Alliance Resource Partners wasn’t a market favorite; over the past five years, ARLP stock has lost more than half of its value.
The neat thing is, the situation at the company may not be as bad as its unit price movement suggests. And from an income investor’s perspective, the MLP’s oversized distributions could be an opportunity.
Alliance Resource Partners, L.P. Is Maintaining a Safe Payout
Like most MLPs, Alliance Resource Partners reports something called distributable cash flow (DCF). It is calculated by taking adjusted earnings before interest, tax, depreciation, and amortization, then deducting interest expense, interest income, income taxes, and estimated maintenance capital expenditures.
By comparing a company’s DCF to its cash distributions in a given reporting period, investors can see whether the partnership generated enough cash to cover its payout.
Alliance Resource Partners, L.P. last reported earnings on October 29, 2018. In the third quarter of that year, the partnership generated $97.2 million in DCF, representing a 2.3% increase year-over-year. And since ARLP paid total distributions of $69.2 million to unitholders for the quarter, it achieved a distribution coverage ratio of 1.4 times. (Source: “Alliance Resource Partners, L.P. Reports Increased Financial and Operating Results; Raises Quarterly Cash Distribution to $0.525 Per Unit; and Updates Guidance,” Alliance Resource Partners, L.P., October 29, 2018.)
In other words, the partnership generated 40% more cash than the amount needed to meet its distribution obligation for the quarter.
In the first nine months of 2018, things looked equally impressive. Alliance Resource Partners generated $297.8 million in DCF during this period while paying out $206.7 million in distributions. That translated to a distribution coverage ratio of 1.44 times, leaving a wide margin of safety.
A High-Yield Stock Worth Considering
One of the reasons why the stock market did not warm up to coal producers was its declining production figures. But this issue has been addressed in Alliance Resource Partners’ latest financial results. In the third quarter of 2018, the partnership’s coal sales totaled 10.1 million tons, representing a 4.4% increase from a year earlier.
Coal sale prices also improved, by 1.3% year-over-year to $45.71 per ton in the third quarter. Thanks to higher output and selling prices, Alliance Resource Partners grew its total revenue by 9.8% year-over-year to $497.8 million in the reporting period.
Of course, there is still uncertainty facing the coal industry. But the neat thing is, the company’s marketing team has already found buyers for its future output.
In particular, the partnership has secured volume and price commitments for around 32.9 million tons in 2019, 17.7 million tons in 2020, and 7.9 million tons for 2021. This would add stability to its future business.
The best part is, ARLP stock’s payout has been on the rise. The latest distribution, which was paid on November 14, 2018, represented a four-percent increase year-over-year and a one-percent increase sequentially. Management has raised ARLP stock’s per-unit distribution rate for six consecutive quarters. (Source: “Distributions,” Alliance Resource Partners, L.P., last accessed January 3, 2018.)
The bears can keep bashing the coal industry, but ARLP stock’s 12.1% yield deserves a look.