Better Buy: Alliance Resource Partners LP vs. CONSOL Energy Inc.

By Reuben Gregg Brewer Markets Fool.com

Alliance Resource Partners LP (NASDAQ: ARLP) is a coal miner. CONSOL Energy Inc. (NYSE: CNX) is a coal miner that is currently switching to focusing on natural gas production. If you are an investor looking at this pair, your primary question might be which one has a brighter future in the energy market. However, if you are an income investor, you might find owning a great business in a fading industry is just your speed. Read on to find out more.

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Image source: CONSOL Energy.

Different directions

CONSOL Energy traces its history back to 1864, when several Maryland-based coal mines decided to join forces.To give you an idea of just how long the company has been in business, operation of the original consolidation was delayed by the Civil War. Coal remained the core business up until 2010, when CONSOL paid nearly $3.5 billion to buy the Appalachian natural gas exploration and production business of Dominion Resources, Inc. (NYSE: D).

Since that time, CONSOL has been shifting away from coal and toward natural gas. This shift has included additional acquisitions, coal mine sales, the elimination of the company's dividend, and the spin off of CNX Coal Resources LP (NYSE: CNXC). That partnership allows CONSOL to sell (or "drop down," in limited partnership lingo) assets while still retaining control of them and benefiting from them financially to some degree. But the direction the company has taken is clear: It's pivoting away from coal.

CNX is now a "passive" owner of coal. Image source: CONSOL Energy.

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Alliance, on the other hand, is sticking with coal. Its business is centered around the Illinois Coal Basin, where it had been expanding production up until 2016. That's a bit unusual compared to other coal miners, many of which have been trimming production for years because of slack demand. Cloud Peak Energy (NYSE: CLD), for example, has been reducing production since 2011 to deal with falling demand for its Powder River Basin coal.

The demand drop off was largely driven by low natural gas prices, which led utilities to switch to the cleaner-burning alternative. In fact, some of Alliance's largest competitors, like Arch Coal and Peabody Energy, have found themselves in bankruptcy court.

Location matters

The fact that Alliance was able to keep expanding while so many competitors couldn't is an important issue to understand. Illinois Basin coal has been gaining market share from competing coal regions in the United States. And, more importantly, the U.S. Energy Information Administration (EIA) expects that trend to continue.

EIA coal projections out to 2040. Image source: U.S. Energy Information Administration.

At first blush, the coal trends on the above graph are pretty dismal, with the large production drops in the Western and Appalachia regions providing a painful image of coal's decline. But along the bottom is the Interior region, which includes the Illinois Basin. It's been bumping along reasonably well and is projected to see stable to rising demand, even in the EIA's worst-case scenario.

So Alliance is in the right place for coal. But it also has staying power. For example, while competitors have been bleeding red ink, Alliance has remained profitable throughout coal's downturn. A big part of that is a conservative balance sheet, where long-term debt makes up less than 15% of the capital structure. And, after a distribution cut in early 2016, it covered its distribution in the third quarter by over two times -- a huge amount of distribution coverage for a limited partnership. The units currently yield around 7%.

It's not dead yet

If you are worried about coal's future, then CONSOL and its shift away from that fuel source is the right choice for you. Natural gas is definitely gaining at coal's expense. However, if you have a little bit of a contrarian streak, Alliance Resource Partners is still a very attractive investment opportunity for income investors. While you shouldn't go in expecting much fundamental growth, the coal it mines is expected to see stable demand or even better over the next two decades or so. And that should support steady payouts from this financially strong partnership for years into the future. Sometimes it can pay to stick with the slow-but-steady play.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners and Dominion Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.