Buy This, Not That: A “Dirty” Player With an 11% Yield

Shah Gilani|October 23, 2024

I’m going to let you in on a “dirty” little secret…

Coal isn’t going anywhere.

It powers utilities across 25 states… production has been stable for the past five years… and global demand remains strong, especially in India and China.

So today we’re looking at two big players in the coal industry… both with solid revenue streams and solid profit margins…

But only one deserves a spot in your portfolio.

I’ll give you a hint as to why… it has a huge 11% dividend.

And that’s just one reason I like it so much.

Get the details in my latest Buy This, Not That episode.

Click on the thumbnail to dive in.

 

TRANSCRIPT

Shah Gilani here with your weekly BTNT. This week I’m going to talk about two coal companies. Why coal? Because a lot of you asked me about coal, about what was the best coal stock company to own.

Now, there are a lot of them out there, so I’m going with two of them. I’m going to compare those two and tell you which one to Buy and which one Not to Buy.

Coal is still being used to power our generators, to power giant utilities, and it’s not going anywhere anytime soon. Coal production is off slightly, but coal use has been pretty flat for about the last five years in the United States.

Yes, it’s still a thing in the United States. Coal is actually mined in about 25 states. So a lot of activity in coal, a lot of employment in the coal industry in the U.S., and coal still matters.

Globally, even more so. India and China are huge consumers of coal. It mostly powers their electricity plants, their utilities. Not all, but the majority of them are still powered by coal, especially in India.

Now, China’s moving more to nuclear, but expectations are for China’s coal output and for use to increase 6% next year.

And in India, there’s a similar expectation for greater use of coal next year.

Coal’s not going anywhere.

So, first up is Peabody Energy (BTU). This is the largest coal company, based in St. Louis. They mine coal in the U.S. and around the world.

They sell to utilities in the U.S. They sell metallurgical coal. They are global. They sell everywhere.

So I’m going pull up a three-year for Peabody. The point I want to make here is it’s gone up a little bit, but then absolutely sideways… because it’s a coal company.

Is it cheap in terms of P/E?

Yes. It’s P/E is around 6.4 on a forward basis.

So cheap, relatively speaking, but that’s because it’s coal.

Again, it’s the largest U.S.-based coal producer. Its market cap is $3.12 billion.

It’s got a pretty nice balance sheet. As far as revenue goes, it banked $4.34 billion over the trailing 12 months. That’s pretty solid revenue. Profit margin is 12.69%.

Very nice.

The balance sheet, no complaints there. It has $621 million in cash and $425 million in debt. Operating cash flow over the trailing 12 months is $422 million.

What I do not like is that the levered free cash flow is negative $221 million.

Levered free cash flow is the cash you have left after you pay all your financial obligations, i.e. interest and whatever other financial obligations you have that you must pay. Well, when you’re done paying those, you get the levered free cash flow number. It’s negative for Peabody.

Not good.

Another thing that’s not good? Looking at the chart, you should be asking, “Shah, why should I invest in this?”

That’s a good question. I would say not to, because there’s nothing there in terms of potential appreciation that’s really stunning.

However, there’s nothing there either in terms of the dividend.

The dividend yield is 1.21% on a tiny payout ratio. Yes, management could raise the dividend, but they haven’t.

In sum… I’m not impressed with the levered free cash flow… certainly not impressed with the dividend yield… and I’m not impressed with Peabody.

And another thing… The president, CEO, and director makes $3.88 million a year in salary.

The CFO makes $1.93 million, and the COO makes $2.17 million. So they’re paying themselves nicely here and the company’s not doing badly… but it’s NOT a buy.

I would not buy Peabody Energy. It does nothing for me. The chart looks fine, it’s just flat. Where are you going to get the appreciation from?

Good luck with that. Can Peabody go higher? Yes. But then you’re sitting on a stock that you’re collecting a tiny dividend on… just to sit there and maybe go sideways.

That’s a NOT for me.

So what you should buy instead, if you’re looking for a coal company, is Alliance Resources Partners (ARLP).

Here’s the three-year chart…

Looks a little bit better, doesn’t it?

The margin between the 50-day (blue line) and the 200-day (red line) is much wider here. So it’s actually in better shape.

Alliance is a master limited partnership, or MLP. I’ll get to that in a second.

Alliance has a similar market cap to Peabody, only slightly bigger. Alliance is at $3.21 billion, and Peabody is at $3.12 billion.

As far as revenues, Peabody has much bigger revenues at $4.34 billion. Alliance’s revenues are at $2.51 billion. But Alliance’s profit margin is 21.3% versus Peabody’s 12.69% profit margin.

So Alliance is more profitable.

Both of them have similar net income available to common shareholders, which is a net profit measure I like to use. Both of them are at around $550 million.

I like Alliance’s chart better. I think it has better chance of making a new high.

And before I tell you what I absolutely love the most about the company, the balance sheet’s not bad. Balance sheet is sitting on $203 million in cash and $498 million in debt.

Not as good looking of a balance sheet as Peabody’s, but Alliance’s operating cash flow is $755 million. That’s significantly higher than Peabody’s operating cash flow of $422 million over the trailing 12 months.

And Alliance has positive levered free cash flow of $92 million over the trailing 12 months.

So yes, they have extra cash if they want to reinvest in the business. Maybe buy back some of shares.

So, why should you buy this over Peabody?

The chart may not be that compelling to me… but what is compelling is the dividend yield of 11.18%. That’s on a payout ratio of 70%.

Now, it’s a master limited partnership, so the dividend yield is actually called a distribution. But it’s the same thing as a dividend. And that 11.18% is versus 1.21% for Peabody.

Alliance just knocks it out of the park.

So if you’re going to hold a coal company, at least get paid for it.

Now, since Alliance is an MLP, you’re going to get a K-1. You’ll have to work that out with your accountant, but that’s not a bad thing.

There could be a possibility that you get paid that kind of big yield and get a K-1 that shows no profits and no tax to pay because the way MLP can organize itself in terms of how it expenses things. You could end up with a K-1 and have nothing to pay on it.

Your accountant will help you with that. K-1s don’t bother me.

It’s worth it for that dividend yield at a 70% payout ratio. That’s a healthy payout ratio.

That dividend is not in trouble. Management has been raising the dividend pretty steadily. I like the dividend. I love the stock for the dividend, not for the kind of appreciation you’re going to get out of the stock.

And here’s what I like most…

I talked to you about how much the Peabody executives were making.

The chairman, president, CEO – one man – at Alliance takes a $1 annual salary. The senior operating partner and CFO, $602,000. Nothing like the millions that Peabody’s paying its executive. The COO of Alliance has a $833,000 salary.

Why so little? Why is the chairman, president, CEO only paying himself a dollar?

Because 29% of the outstanding shares are held by insiders. I like that. They want their dividends. That’s obviously how they’re getting paid. So they like the dividends, and they’re going to continue to get paid, and of course they have appreciation, and they have other perks of being owners of the company.

But here you have 29% held by insiders, and institutions hold 18.4%. Looking at Peabody, insiders own 0.49%. I like investing in a company that whose managers and principles have big skin in the game.

And that’s the case of Alliance Resources. So if you’re so inclined to buy a coal company, buy Alliance Resource Partners.

Not Peabody Energy.

That’s it. I’ll catch you guys next week. Cheers.