Sometimes you can find the best investment options by going against the crowd. That can be hard to do, especially in industries that are deeply out of favor. But here are two stocks that everyone is wrong about: coal miner Alliance Resource Partners, L.P. (NASDAQ: ARLP) and heavily indebted midstream player Holly Energy Partners, L.P. (NYSE: HEP). Here's why you should consider going against the grain with this pair.
Plenty of time
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The media is filled with news suggesting the imminent death of coal because it is among the dirtiest fuel options around. While the trend is clearly going in the wrong direction for coal, it's hardly dead yet. For example, the U.S. Energy Information Administration projects that coal will continue to be an important fuel option for domestic electric producers until at least 2040... and likely well beyond, only its projection period currently stops at 2040.
But it's important to be in the right coal region. On that score, the interior region is expected to grow its share of coal shipments from 20% last year to 26% in 2040. Alliance Resource Partners' operations are focused in the Illinois Basin in the interior coal region. But this is just a continuation of a long-running trend, which also helps explain why Alliance's production is up 20% since 2010 while competitor Cloud Peak Energy (NYSE: CLD), which is focused on the Powder River basin, has seen its production decline a painful 35% over the same span.
And then there's the fact that, even during the darkest days for coal, Alliance managed to turn a profit every year. That's something few if any peers can claim, with many, like giant Peabody Energy, falling into bankruptcy. Alliance's outperformance is a trend that doesn't look likely to end in the near term.
While it's true that Alliance cut its distribution last year, that was largely to assuage the concerns of capital markets -- not because it needed to save money. It actually covered the lower distribution by a massive two times in 2016 and hinted after the first quarter of this year that a resumption of distribution hikes might be in the cards.
These are not facts that suggest a dying business. While the headlines proclaim coal is dead, you should consider doing a deep dive at coal miner Alliance Resource Partners and collect the fat 9% (or so) distribution yield this industry-leading partnership offers.
That's a lot of debt
Long-term debt makes up around 75% of Holly Energy Partners' capital structure. That's a heavy debt load. The absolute level of the partnership's debt, which was roughly $1.24 billion at the end of the first quarter, is up materially since the start of 2015, when debt stood at roughly $870 million. Looking at debt in a different way, interest expense increased just over 45% between 2014 and 2016.
There's no way around it, Holly Energy Partners has a lot of debt. Which is part of the reason why the units yield 7.7% compared to less indebted peers like Enterprise Products Partners which yields 6.2%. There's obviously more that differentiates this pair, but debt is a big one. Only Holly looks capable of shouldering the extra burden while it works to digest the growth enhancing acquisitions that led to the additional leverage.
But if you looked at the first quarter results you might start to worry. For example, distribution coverage was just 1 times in the quarter, meaning it covered the disbursement -- but barely. Net income, meanwhile, fell 75% year over year. Those aren't good numbers, but there's a reason. For starters, Holly Energy paid down $300 million worth of debt in the quarter that resulted in a one-time charge. And one of the partnership's key customers, general partner HollyFrontier, was doing scheduled work at a facility that led to reduced volume on Holly Energy's pipes. So the quarter wasn't as bad as it may have first seemed.
Longer term, it's important to remember that 100% of Holly Energy's revenues are fee based with over 80% under long-term contracts. Its cash flow, then, is highly reliable. In fact distributable cash flow was actually higher by 3.5% year over year in the first quarter despite the headwinds. In the end, the first quarter looks like an aberration, not a sign of trouble.
Which helps explain why management felt comfortable enough to hike the distribution for the 50th consecutive quarter, leaving the disbursement roughly 8% higher compared to the first quarter of 2016. Meanwhile, if you can look past the leverage numbers, you can collect the partnership's growing distribution and hefty yield while it works to pay down debt.
A contrarian bent
It can be easy to get caught up in the headlines, and investors often do. But when you dig a little deeper into the facts you often find that some companies are being painted with too broad a brush. That's the case with coal miner Alliance Resource Partners and debt-heavy midstream company Holly Energy Partners. If you are willing to go against the crowd with this pair, you can collect impressive yields backed by solid businesses.
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