From the April 2011 issue of Research Magazine • Subscribe!

Coal: Picking Up Steam

Steady coal demand and earnings growth should benefit total-return investors.

Paul Forward, CFA
Stifel Nicolaus
443-224-1379
pforward@stifel.com

U.S. coal production was up 3.7% year over year (y/y) in the week ended February 12, at 20.7 million tons. Overall U.S. coal production is up 3.1% year to date (ytd). Eastern coal production was up 13.9% y/y in the latest week, and up 6.3% ytd. Western coal production was down 3.1% y/y in the latest week, but up 0.9% ytd. For 2011, we estimate that the weekly draw on U.S. coal (i.e., domestic consumption plus net exports) will be 21.6 million tons.

For utility coal stockpile information, we are reporting published information from the Energy Information Administration (EIA). EIA’s latest stockpile estimate for December 2010 is 175.3 million tons, 34.0% above the 10-year average but 7.5% below the year-ago stockpile level.

We estimate that stockpiles represented 65.5 days of coal consumption, 29.6% above the 10-year average of 50.6 days for December at month-end. The stockpile total of 175.3 million tons implied a monthly draw of 7.5 million tons vs. the 10-year average monthly draw of about 4.7 million tons during December.

In 2010, U.S. coal markets were in deficit by 24 million tons, driven by year over year increases in domestic power generation of 43 million tons and coking coal exports of 19 million tons. We expect the U.S. coal market will remain in deficit in 2011 by 16 million tons. Our assumptions include an increase in Appalachian output of 1% and Interior output of 4.4% over 2010 levels.

We are raising estimates for Alliance Resource Partners (ARLP) following the company’s 4Q10 earnings release and conference call.

Alliance reported 4Q10 earnings per unit (EPU) of $1.82, above our estimate of $1.60 and above the Street consensus of $1.66. EBITDA (earnings before interest, taxes, depreciation and amortization) was $132 million versus our $123 million estimate and the Street consensus of $123 million.

The earnings beat was the result of better-than-expected pricing and sales volumes in Alliance’s Central and Northern Appalachian operations, offset by a slight volume and margin miss vs. our estimates in the Illinois Basin. Alliance reported a reduction in quarter over quarter (q/q) costs per ton in each of its operating regions due to reduced workers’ compensation accruals which also helped lift earnings during the quarter.

Illinois Basin sales volumes totaled 6.3 million tons in 4Q10, below our estimate of 6.8 million tons and even with the 6.3 million tons realized in 3Q10. Pricing of $47.71/ton was just shy our $48.08/ton estimate, but costs of $29.28/ton were below our $30.05/ton estimate.

In Central Appalachia, 4Q10 sales of 542,000 tons were above our estimate of 525,000 tons and above the 3Q10 sales volume of 531,000 tons.

Realized pricing was $79.16/ton (above our $76.84/ton estimate) and costs were $56.11/ton (below our $62.01/ton estimate). In Northern Appalachia, sales volumes of 888,000 tons were ahead of our estimate of 806,000 tons and above 3Q10’s sales of 837,000  tons in the region. Realized pricing of $67.57/ton was above our $66.07/ton estimate and costs of $49.58/ton were below our $53.50/ton estimate.

ARLP announced an increase in the cash distribution for 4Q10 to $0.86 per unit (an annualized rate of $3.44 per unit). This distribution represents a 3.6% increase over the $0.83 that was paid to unit holders in 3Q10.

Peter D. Ward, CFA
Barclays Capital
212-526-4016
pete.ward@barcap.com

Natural Resource Partners (NRP) reported-fourth quarter net income per unit of $0.39, above our estimate of $0.36/unit and the consensus estimate of $0.34/unit. As was the case last quarter, NRP benefitted from ongoing strength in the metallurgical coal markets, although royalties did decline slightly quarter over quarter, from $4.86 in 3Q10 to $4.67 in 4Q10.

Quarterly lessee volumes came in above our expectations for the quarter at 12.1 million tons. This was slightly below NRP’s lessee volumes in 3Q10, which stood at 12.4 million tons. NRP expects 2011 volumes to benefit somewhat from increased lessee production at the Deer Run mine in the Illinois Basin. Production from the Deer Run mine is expected to “dramatically increase” in 2012 as the long-wall production commences.

In terms of market outlook, the partnership expects to benefit from both stronger metallurgical and thermal coal pricing over the course of 2011 following a wave of global supply disruptions.

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