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Can This Coal Company's High-Yield Dividend Even Survive?

Source: Alliance Resource Partners corporate website

Whenever a company has a dividend yield as high as coal miner Alliance Resource Partners (NASDAQ: ARLP), your first reaction should be to ask, "What's wrong?" In the case of Alliance's 10% yield, the company's stock has been punished by a chronically weak coal market in which the three biggest players have filed for Chapter 11 in the past year alone. Considering how brutal the coal mining business is today, it's fair to wonder whether Alliance's dividend will hold up over the long term. So let's take a look at the cases for and against those regular payouts lasting.

The case against: A coal market continuing to struggle

For more than five years now, coal consumption in the U.S. has declined steadily. Growth in the supply of cheap natural gas, a precipitous decline in the costs to generate energy from renewable sources such as solar and wind, and a tightening of regulations on power plant emissions in the U.S. and abroad have all been major factors lowering demand for coal. 

To make matters worse for coal miners, all of those trends are continuing, so there are few reasons to think that coal demand will stabilize, let alone recover, for a very, very long time. 

There is another side of the coin that is less discussed, though -- the persistent overproduction by coal miners, which has led to massive oversupplies. Today, utilities' coal inventories are enough to supply power for more than 100 days, which is one of the highest levels of all time. Part of the reason we're seeing such high supplies of coal is that many distressed miners continue to produce it even though economically, it barely make sense for them to do so.

For example, the now-bankrupt miner Alpha Natural Resources' cash costs to mine coal were greater than the mineral's selling price at the time of its last financial disclosure. Yet the company continues to mine coal while under bankruptcy protection, apparently in order to pay off its debts. Yet it's hard to imagine how the company can pay what it owes its creditors when the cost to dig coal out of the ground is higher than the price it will be paid when it sells it.

Alpha isn't the only company in this predicament, either. Three of the nations largest coal miners by volumes sold are also in bankruptcy protection, but continue to sell product at extremely depressed prices hoping to pay back their lenders. If these seemingly dead companies continue to pour supply into a market that is in structural decline, how can miners like Alliance that are still in business expect to get better prices?

The case for: A well run business

Despite all the market forces arrayed against Alliance and its dividend payment, you have to give the company's management credit for steering the company with a solid business strategy, and avoiding the pitfalls that ensnared so many other coal managers. Alliance has focused its efforts on the Illinois Basin, where coal-producing costs are much lower cost than the in the older mines of the Appalachian region, and which is better located to supply power plants in the Central and Southeastern U.S. than the Powder River Basin mines of the West. Also, while all of those now-bankrupt companies blew up their balance sheets by making big acquisitions at what turned out to be the top of the market in 2011, Alliance's management team kept their heads down, and focused on keeping costs low and maintaining balance sheet integrity. 

All of that explains how the company has been able to keep producing profits and paying dividends. When management cut its payout at the end of the first quarter, the company was still projecting that it would have enough cash coming in the door to support the higher dividend. However, management was smart enough to realize that it was better to use that cash in other parts of the business, and prepare in case its outlook became materially worse. This shows a management team with the foresight to protect the long-term viability of the company, but it's also one that has been very generous to shareholders over the years. If management continues to run the business this way, it should keep paying some form of dividend over the long term.

The verdict

The market for coal is likely to keep getting smaller, but the decline will probably take a while, because power companies aren't going to shut down coal plants without alternatives in place. The biggest concern for Alliance is whether other miners will finally face the writing on the wall and stop producing unprofitable coal into an oversupplied market. 

The longer the current conditions hold, the less likely it is that Alliance will be able to sustain its dividend over the long term. So investors whose preferred strategy is to buy and hold for years at a time may want to look elsewhere. Management will probably do everything it can to do right by its shareholders for as long as possible, but chances are, Alliance's dividend will eventually come to an end.

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Tyler Crowe has no position in any stocks mentioned. You can follow him at Fool.com or on Twitter 

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