High Hopes In Diversification Amid Analysts' Concerns Over Coal's Future And Shrinking Margins

Key Takeaways

• Alliance Resource Partners' strategic financial moves and diversification signal strong investor confidence and potential for growth in earnings and stability.
  
• Expansion into digital asset mining and leveraging increased U.S. electricity demand indicate innovative revenue diversification and growth opportunities.
  
• Reliance on thermal coal and operational challenges, amidst environmental pressures and market volatility, threaten revenue, efficiency, and investor confidence.

Catalysts

A diversified natural resource company, produces and markets coal primarily to utilities and industrial users in the United States.

• The successful issuance of $400 million of 8.625% senior unsecured notes and the extension and amendment of the $425 million revolving credit facility indicate strong investor confidence and increased liquidity, potentially improving the company's ability to invest in growth opportunities and manage debt, which could positively affect earnings and financial stability.
  
• Alliance Resource Partners' emphasis on its solid track record as a reliable, low-cost coal producer with established domestic and export markets points to sustained cash flow generation capabilities. This sustained cash flow can support operational efficiency and profitability, further enhancing net margins and revenue growth.
  
• The oil and gas royalty segment's notable growth from a segment adjusted EBITDA of $42 million in 2020 to $122 million in 2023 suggests a diversification of revenue streams with high-margin contributions. This growth trajectory is likely to positively impact overall earnings and provide a hedge against coal market volatility.
  
• Expectations of increased U.S. electricity demand driven by the electric vehicle sector, onshore manufacturing, data centers, and the AI revolution present significant growth opportunities for Alliance Resource Partners. Anticipated higher demand for coal could increase sales volumes and prices, directly benefiting revenue and margins.
  
• The company's initiative into digital asset mining as a pilot project to monetize underutilized electricity load capacity represents a forward-looking approach to leveraging existing assets for additional revenue streams. While nascent, the success and expansion of this project could offer a novel revenue source and diversify the company's income, potentially impacting net income positively.

Assumptions

• Analysts are assuming Alliance Resource Partners's revenue will decrease by -1.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 20.5% today to 16.2% in 3 years time.
• Analysts expect earnings to reach $387.2 million (and earnings per share of $2.9) by about September 2027, down from $514.0 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.2x on those 2027 earnings, up from 5.7x today. This future PE is greater than the current PE for the US Oil and Gas industry at 9.8x.
• Analysts expect the number of shares outstanding to grow by 0.74% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.21%, as per the Simply Wall St company report.

Risks

• The reliance on thermal coal production amidst a global push for cleaner energy sources could lead to decreased demand, affecting revenue and profitability.
  
• High water levels and lock outages on the Ohio River and lower than expected export shipments increasing coal inventories signal potential logistical and market access challenges that could affect sales volumes and revenue.
  
• The decrease in coal sales volumes and production, due to both environmental and operational factors, may negatively impact overall revenue generation and operational efficiency.
  
• The volatility and decrease in the fair value of digital assets such as Bitcoin add a layer of financial risk that could impact net income adversely, reflecting broader market uncertainties that could affect investor confidence.
  
• The revised guidance reflecting lowered coal sales volumes, despite increased sales price per ton, indicates challenges in balancing production and market demand that could lead to missed revenue opportunities and impact margins.

Valuation

• The analysts have a consensus price target of $27.0 for Alliance Resource Partners based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.4 billion, earnings will come to $387.2 million, and it would be trading on a PE ratio of 11.2x, assuming you use a discount rate of 7.2%.
• Given the current share price of $22.97, the analyst's price target of $27.0 is 14.9% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.