Is Alliance Resources under-accruing workers compensation obligations?

My last post on Alliance Resources explored the differences between Alliance Resources (the best performing coal operation in North America) with Patriot Coal (famously and massively bankrupt).

Patriot produced only slightly less coal per worker (a key measure of cost-competitiveness) and it was higher quality coal.

Patriot had less debt.

They were about the same size - but alas - Patriot was bankrupt and so difficult to run they were closing mines in bankruptcy.

The differences lay in the balance sheet where Patriot had large post retirement benefit obligations and Alliance does not - and Patriot had large workers compensation obligations and Alliance does not.

The first one I understood. Patriot was heavily unionized. Alliance was not.

However the second one I did not understand. These were multi-mine operations in similar jurisdictions with similar numbers of employees. They both self-insure workers compensation. Unless one operation is massively safer than the other they should have similar workers compensation obligations.

I was puzzled.

So I went looking.

Here is the flows into and out of the workers compensation provision for the last full (non-bankrupt) year at the last 10-K for Patriot Coal...

		December 31,
		2011				2010
		(Dollars in thousands)
Change in benefit obligation:
Beginning of year obligation		$	174,014			$	152,079
Service cost		7,496				9,258
Interest cost		9,492				8,963
Net change in actuarial gain		3,536				12,668
Benefit and administrative payments		(8,899		)		(8,954		)
Net obligation at end of year		185,639				174,014
Change in plan assets:
Fair value of plan assets at beginning of period		—				—
Employer contributions		8,899				8,954
Benefits paid		(8,899		)		(8,954		)
Fair value of plan assets at end of period		—				—
Obligation at end of period		$	185,639			$	174,014

Patriot Coal had $8.889 million in payments and an estimated total obligation of $185.6 million. The estimate of total obligation is 20.9 times current payments.

This compares with the last 10-K disclosure for Alliance Resources:

	2012	2011
Beginning balance	$73,201.00	$67,687.00
Accruals	$24,812.00	$22,254.00
Payments	($10,477.00)	($11,235.00)
Interest accretion	$2,739.00	$3,174.00
Valuation gain	($13,229.00)	($8,679.00)
Ending balance	$77,046.00	$73,201.00

Payments were $10.48 million - a little higher than Patriot. However reserves were only 77.0 million. The estimate of total obligations is only 7.35 times.

Alliance Resources is - relatively to Patriot - extremely under-reserved for workers compensation.

If we were to reserve Alliance Resources on the same basis as Patriot we would have to add $141 million to reserves.

This difference has accumulated over time. If Alliance had used Patriots conservative reserving pre-tax earnings (and hence EBITDA) would be cumulatively $141 million lower than were actually recorded. This is clearly part of the reason why Alliance appears so profitable relative to the competition.

More importantly because Alliance is an MLP which distributes roughly its EBITDA, if a more conservative reserving had been used Alliance's distributions would cumulatively been about $140 million lower.

I wonder how the workers expecting to be paid compensation feel about having the money backing their compensation distributed to MLP unit holders?

In my crystal ball I see a class action.





John



Post script:

Dear Class Action lawyers - there is this little disclosure in the 10-K which might make any future class action more - well - rewarding. I will leave it to the unit holders, their lawyers and the general partner to interpret this:

Your liability as a limited partner may not be limited, and our unitholders may have to repay distributions or make additional contributions to us under certain circumstances. 

As a limited partner in a partnership organized under Delaware law, you could be held liable for our obligations to the same extent as a general partner if you participate in the "control" of our business. Our general partners generally have unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to our general partners. Additionally, the limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in many jurisdictions. 

Under certain circumstances, our unitholders may have to repay amounts wrongfully distributed to them. Under Delaware law, we may not make a distribution to our unitholders if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of the impermissible distribution, partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the partnership for the distribution amount. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.

Promising yield: Roddy Boyd on Brookfield Asset Management

Perhaps the easiest financial product to sell is one that offers safety plus a high yield. Of course the product may only offer the illusion of safety plus a high yield (safety plus a high yield being rather hard to obtain). But that won't stop it selling well. Often very well.

Bernie Madoff - apart from being a degenerate wart was the best salesman of hedge funds in the history of the business. No legitimate hedge fund has ever raised $10 billion let alone $50 billion without a huge sales force. Madoff managed that. The cumulative money raised by authentic financial geniuses (Buffett or even Loeb, Einhorn et al) is a small fraction of what Bernie raised. I can assure you as someone running a completely legitimate operation we have raised less in three years than Bernie raised on many days.

In money management what sells is the illusion of certainty... a fund manager who tells the truth (the truth being that he may be wrong at any time) is a more-difficult sale but a better investment.

High yields plus the illusion of certainty make my ears prick up. And it is common enough. In Australia there were two large businesses that sold unit trusts of some description to the public which housed "safe" assets like tollways and airports. These "safe" assets were levered to the point that they were not very safe any more but the leverage and - to some extent distributions paid out of capital - gave them yield.

The managers of these trusts were Macquarie Bank and Babcock and Brown.

In some instances the story was simple. Assets were revalued, borrowings were made against those revaluations and distributions were paid.

Macquarie Bank is still with us - partly saved by the Government guarantee of bank funding and partly saved by having some real and profitable businesses. Macquarie is - like many investment banks - a shadow of its former self. But it is still a real and powerful operation.

Babcock and Brown has gone to meet its maker though a surprising number of ex-B&B staffers are very wealthy.

The investors in the unit trusts mostly did not fare so well. Still some trusts survived - and ex-ante it was hard to tell the Ponzis from the merely over-levered from the well managed. Even ex-post it is hard to tell Ponzis from over-levered - and nobody has been charged with anything criminal anyway.

Often compared to Macquarie and Babcock was the Canadian operation of wheeler-dealers known as Brookfield Asset Management. Unlike Macquarie and Babcock Brookfield is still with us - and largely unimpaired. Its unit holders are not yet angry let-alone resigned to their losses. [Babcock structure unit holders are well past the "resigned" state now...]

But the formula seems remarkably similar (and similar to some MLPs). The formula - find an asset that is fairly stable - not riskless but low risk - and sell a structure based on that asset to mostly a pensioner-needing income investor set. The yield is made possible by either leveraging the asset with debt or endless capital raises.

In all the nasty cases (and in some less nasty cases) the wheeler-dealers did considerably better the holders of the investment vehicles. Pay was not commensurate with long term performance.

Anyway I spent a lot of time (often wasted) picking apart Macquarie structures before the bust. I should have been picking apart Babcock structures because Babcock performed far worse than Macqaurie.

I never got around to picking apart Brookfield because it was so darn complicated. Just breathtakingly complex.

But that doesn't mean it is not worth the effort. If you want to understand what it was like to try and understand Babcock or Macquarie before the denouement you can.

And you do not have to make much of an effort. Roddy Boyd (bless his hard-working soul) has done much of the work for you. And put it online.

Go read it.

The investment required is not large. But reading Roddy is low risk. And this time I can promise you a high yield.





John

Alliance Resources vs Patriot Coal

Alliance Resources (a minor obsession of mine) is financially the best performed coal company in America. The stock is near all time records - and distributions are large and unimpaired.

Patriot Coal is in a spectacular bankruptcy.

I thought it reasonable to compare the best of the best with the worst of the worst - just to see how different they really were - perhaps so I could pin down what made Alliance Resources special.

Here the companies are compared by tons, employees and tons per employee.

	Patriot Coal			Alliance Resources
	tons (millions)	Employees	tons/ employees	tons (millions)	Employees	tons/ employees
2007	22.1	2300	9609	24.3	2600	9346
2008	28.5	4300	6628	26.4	2955	8934
2009	32.8	3500	9371	25.8	3090	8350
2010	30.9	3700	8351	28.9	3558	8123
2011	31.1	4300	7233	30.8	3832	8038
2012	24.9	4100	6073	35.2	4345	8101
2007-11	145.4	18100	8033	136.2	16035	8494
2007-12	170.3	22200	7671	171.4	20380	8410

Alliance is better - it is smoother for instance - which means less hiring and firing. And it does not have the crash in productivity at the end - but that crash happened after the bankruptcy.

But it is not massively different.

It probably makes sense to use the balance sheet data from 2011 (before multiple restatements) rather than 2012 to examine Patriot because that was before the bankruptcy mucked everything up. In those days Patriot was still humming along (admittedly in some distress).

Patriot had considerably less machinery but more "buildings and improvements" than Alliance. That figures - some of Patriot's operations were open-cut whereas Alliance is entirely an underground miner. Open-cut mining involves lots of "improvements" (although some would argue removing hills does not constituted improvement.)

Patriot produced far better coal. Some of their coal was metallurgical - and most was lower sulfur. This coal should get a massive premium price - so that is one in favor of Patriot.

Patriot had in 2011 way less debt than Alliance has now. This is kind of amazing - you can go spectacularly bankrupt with an operation this size and this level of productivity.

The main difference is in the size of other balance sheet liabilities. Patriot had $238 million in workers compensation obligations (2011) versus Alliance having only $68 million (2012). Even more pronounced is the post-retirement obligations where Patriot had $1387 million (2011) versus Alliance at  a mere $31 million. Alliance might say that this was the benefit of a non-unionized workforce but if that is the case then union concessions would be enough to revive Patriot (and that does not look likely).

There is quite a deal that is strange and unusual about this story.



John

Verizon-Vodafone: it is time to go hostile

The Wall Street Journal is again suggesting that Verizon may buy Verizon Wireless from Vodafone. As noted in the previous post this is insane. It incurs a completely unnecessary twenty billion dollar tax bill.

The only deal that makes sense is for Verizon to buy Vodafone in its entirety.

If Vodafone will not sell there is a solution for Verizon: go hostile.

Background

As detailed in the previous post Vodafone has been had a decade of modest successes and abject failures made good by a single amazing success. The amazing success is that they owned 45 percent of Verizon Wireless - the best performed US Wireless company.

I noted that Vodafone's great success is the only substantial asset that they do not manage.

Several UK fund managers (reasonably) pointed out that this was not entirely fair. The history is instructive. During the tech-bubble Vodafone got properly carried away. Not only did they pay up for spectrum (which may not have been a choice given WorldCom competing at auctions) but they paid top-dollar for several assets entirely by choice. The biggest mistake was that they purchased Mannesmann at the height of the bubble for $170 billion USD. This deal is second only to AOL-Time Warner as the most stupid large deal of the tech-bubble era.

Over the next couple of years the delusional bubble-era management were replaced by bland mediocrities who did not do very much wrong at the cost of not doing very much right. Vodafone had completely "rogered" its balance sheet during the bubble and as a result did not participate in the cheap spectrum auctions around the world that happened during the 2002-2007 period. Getting carried away in a bubble has permanent effects (just ask Citigroup or BofA if you need more recent examples).

My UK fund-manager contacts thought that I was being harsh on Vodafone criticizing current management for their complete lack of spark. They thought the current management were chosen to be boring and fulfilled that task admirably.

By contrast, the Baby Bells did not participate much in the madness of the tech bubble - leaving that to the CLECs (anyone remember McLeod) and Worldcom and Enron Broadband, Global Crossing and the like. The Baby Bells were boring.

As befits the end of a bubble - the meek were left standing and inherited much of the USA. The Baby Bells consolidated to form Verizon and AT&T and have solid balance sheets, good businesses and the absence of insane competition.

Their cycle was the opposite of Vodafone. They were boring when Vodafone was exciting and they are now strong when Vodafone is weak.

In any deal Verizon deals from that strength - strength created more than a decade ago.

Hostile bids

Sir Brian Pitman once told me that the only real bids are hostile bids. He had a sort of logic: in a negotiated bid it is highly unlikely the acquirer is getting an outright bargain. Negotiated bids happen with a willing seller.

Hostile bids however change the world. The stock market is full of incorrectly valued securities. It is fairly common for stocks to lose 70 percent of their value or triple. As a corollary the stock market is full of securities trading at a third of fair value and three times fair value.

If we could pick which were which we would all be rich. Alas it is very hard to pick what is cheap and what is expensive - and the investing world is full of "if-only" statements. [If only I had purchased Citigroup below a dollar...]

Hostile bids are typically done without due diligence - and the range of outcomes is large. In a hostile bid you might pick up an asset for a third of fair value or three times fair value. These extreme outcomes don't happen so much in negotiated bids.

The result: hostile bids change the world. Extreme variation makes hostile bids either extremely good or extremely bad.

This bid does not require much due diligence

Hostile bids can be extremely good or extremely bad because you can't do due diligence.

However in this case if Verizon were to bid for Vodafone Verizon would know what they are getting. The WSJ story linked above suggests that the Verizon Wireless stake is worth between $106 and $137 billion. I have a slightly higher number.

The total market cap of Vodafone is $137 billion.

Vodafone is trading below what I think the stake in Verizon Wireless is worth.

Verizon can bid fair value for what the Wireless stake is worth and get the rest for free - and it is obviously worth more than nothing. Even the Australian asset has some value!

And Verizon obviously do not need to do due diligence on Verizon Wireless.

In other words Verizon can have all the pluses and very few of the negatives of a hostile bid.

A hostile bid is possible of course because the UK fund managers have little faith in the mediocrities that now run Vodafone. Vodafone is cheap because of management.

I know if there is an American bid for this UK champion there would be all sorts of nationalistic squeals in the UK. But the UK fund management community would donkey-like eventually just accept the bid. For Vodafone that is the cost of a decade of failures.

And the meek (the Baby Bells) would in fact inherit the earth.




John

The end of Reader: what does it say about Google?

The blogosphere is full of people who are livid at the end of Google Reader. I am angry too - and would move many of my Google services if there were better alternatives. [I no longer feel secure in the Google promise to continue providing services that are critical to my life...]

Google has not budged. Reader - by far the best RSS feed for people who get their information by reading - is going dark.

Nobody I know however has indicated what this says about Google. So I am going to try.

(a). Reader is a service that not many people use - except that it seems inordinately popular with a bunch of thought-leaders including many of the most widely read bloggers. It amazes me that Google can't take a service that popular with thought leaders and turn it into a mass-market product. This is a management failure - Google is clearly not immune to them.

(b). The mass-market RSS alternative is Twitter. However among the more wordy-and-literate-and-older RSS is still important. My readers are older, better read, and better educated than the average internet user and I have about four times as many RSS followers as I do Twitter followers. Still as a blogger I needed to face the new reality and get a Twitter feed. In abandoning RSS Google is showing the sort of petulance that a mega-company has when it missed a mass-market trend. It seems pretty obvious now that Google is going to want to buy Twitter.

(c). Google is in the process of abandoning its mission. Google's stated mission is to organize all the world's information and make it universally accessible and useful. RSS is a way that a small number of us organize our information. Google no longer cares. It seems what they care about is mass-markets - see the Twitter comments above.

(d). Twenty percent time is dead at Google. Reader was a great product produced by twenty percent time but it was never shown any love - and no serious attempt has ever been made to monetize it. Even if you manage between 8PM on Saturday and 10AM on Sunday (your twenty percent time) to develop a modestly successful product Larry Page will not care. If you want to be entrepreneurial work elsewhere.

(e). Obvious steps to use the RSS feed to extend or expand other Google products have not been made. The idea of shifting your RSS feed into your Google+ account was seemingly not tried. Rather than abandoning Reader Google could have directed all the thought-leader eyeballs to Google+ - and offered more product. I guess Google has also given up trying to make Plus a serious alternative to Facebook. If it is not a mass-market Google is not interested in it.

(f). Google's slogan is "Don't be evil". But the only agenda now is to go after mass markets and make lots of money. Larry Page's self-image is benevolent dictator but really this guy is demoniacally going after big prizes. Larry Page is as evil as Larry Page perceives necessary.

(g). This obsession is going to lead competitors to openings. Yahoo for instance could immediately get all those thought leaders by offering a clone of Google Reader and offering a seamless transition. Feedly might get there (but Yahoo! will then buy them). Ignoring people around the fringes of your market is dangerous.

Bronte owns Google stock and has done so for some time. The new - and evil - Larry Page is going to make lots and lots of money. Short term the stock will probably continue to go up. Long term I am not so sure. Google is annoying its more entrepreneurial staff by killing any pretense of twenty-percent time. Further, Google is leaving openings for competitors. Finally Google has snubbed people around the fringes of their market and deeply pissed off users are clearly negative for Google. Google relies critically on the trust of their users.

I - along with many others - feel betrayed.




John

Further exploring the capital intensity of Alliance Resources

In the last post of my Alliance series I demonstrated on key operating metrics that Alliance Resource Partners was not just a bad coal mining operation - it was a flat-out terrible operation.

It had raised its capital intensity 350 percent, substantially reduced the grade of the coal it exported and reduced labor productivity over 20 percent. And it had become more bureaucratic at the same time.

Moreover the maintenance capital expenditure per ton produced has risen from 43c to over $8. These seem to be fairly brittle machines - put a ton of coal through the chute and you have induced $8 of repair obligations on the kit. Like wow - imagine all the people running around repairing stuff.

This is - to put it mildly - surprising. It is surprising because Alliance Resource Partners is the highest valued coal mining operation in America with the best performing stock. There is at this company a very large disconnect between operational performance and financial performance.

To be fair though - rising capital intensity is a problem across the industry (it is just more intense at Alliance). Peabody is the biggest coal mining company - and a good comparable.

In 2000 Peabody had $5.2 billion of property, plant, equipment and mine development with which they produced roughly 190 million tons. That was roughly $27 of PP&E per ton. (Many of Peabody's tons are lower-quality Powder River Basin tons.)

By 2000 Peabody had 15.4 billion in gross PP&E was 225 million tons. The capital required per ton was now $68.4. The capital intensity had gone up 2.5 times. Clearly this is an industry trend - albeit a worse trend at Alliance than at Peabody.

Employee numbers had moved from 7200 to 8200. Tons per employee thus moved from 26,400 to 27,400 - a slight improvement in labor productivity.

Peabody does not separately identify maintenance capital expenditure - but suffice to note that Peabody's total capital expenditures per ton are well below Alliance's maintenance capital expenditures per ton. Peabody's equipment is clearly less fragile...

The same trends are everywhere I look. The industry has substantial increases in capital intensity - but not as intense as Alliance Resources, but marginal improvements in labor productivity. It is on the labor productivity metric that Alliance stands out most intensely. Alliance has declining labor productivity.

However just how startling Alliance is is better demonstrated when you look only at the plant and equipment part of property plant and equipment.

You see, most of the PP&E at Peabody is land and coal interests - just the right to mine. This is the breakup:

Peabody - $million - 2012
Property, plant, equipment and mine development
Land and coal interests	10947.7
Buildings and improvements	1321.3
Machinery and equipment	3162.2
Less: accumulated depreciation, depletion and amortization	-3629.5
Property, plant, equipment and mine development, net	11801.7

Peabody is only using roughly $4.5 billion gross in buildings, improvements machinery and equipment. And it produces 225 million tons annually.

Alliance Resource partners $million
Mining equipment and processing facilities	1435
Land and mineral rights	304
Buildings, office equipment and improvements	208
Construction in progress	130
Mine development costs	285
Property, plant and equipment, at cost	2362
Less accumulated depreciation, depletion and amortization	−832
Total property, plant and equipment, net	1530

Alliance it seems uses over $1.6 billion (gross) in mining improvements, processing facilities and building improvements to produce about 35 million tons of coal annually.

To put it mildly - Alliance Energy uses a lot of machines both relative to competition and relative to its size and relative to its history.

This thing keeps installing machines and its labor productivity keeps falling.

Very strange. Doubly strange because the profitability measures at Alliance are so outstanding.





John

Vodafone: the only deal that makes sense

I read with a sort of resigned alarm that Vodafone is considering selling its stake in Verizon Wireless. This is absurd - and if it happens it will mark an important part of the British business establishment (and the entire Vodafone board) as both venal and incompetent. Vodafone is our third biggest position at Bronte: this matters to us.

Background

Vodafone has - for the last decade or so - been a collection of modest success and abject failures - made good by one spectacular success. The spectacular success is that they own 45 percent of Verizon Wireless - the best performed wireless carrier in the US.

The failures range from grotesquely overpaying for spectrum in the tech bubble (and hence crippling the balance sheet for a decade) to incompetently stuffing up the most America-like (hence desirable) market out there (my home market of Australia).

The Australian melt-down of Vodafail has been well documented on this blog - but 18 months after the video below - and 18 months after they declared the problem fixed - Vodafone is still the butt of television jokes in Australia:





Vodafone has had some modest successes - eg Turkey - but even their home market has been so unprofitable that Vodafail has been questioned for paying no domestic corporate tax. Of course they should not pay tax if they are not required to do so - but as a shareholder I would prefer them be highly profitable and with big tax bills.

India - which should have been OK - has also been difficult for tax reasons - caused it seems in part by inept management.

There has however been one success - a marvelous success. They own - but do not control Verizon Wireless. It has been a good - no a fantastic asset - and their stake is now worth more than the entirety of Vodafone.

Pointedly this one great success is the one asset they do not manage.

This record has a consequence. Almost all long-term shareholders of Vodafone are not showing substantial gains - and selling their stake would result in only a modest capital gains tax bill - if any bill at all.

However because Verizon Wireless has been so successful selling Verizon Wireless would result in a massive tax bill.

This makes it far more tax efficient for Verizon to buy Vodafone in its entirety than to buy Verizon Wireless. Tens of billions of dollars more efficient.

Any deal where Vodafone sells its Verizon Wireless stake rather than selling itself starts with a tens-of-billions of dollars disadvantage in post-tax shareholder value. It would be insane.

The only justification for such a deal is that shareholders trust Vodafone management to be tens of billions of dollars better with the shareholder money than the shareholders would be themselves.

And sorry - Vodafone management has not earned and does not deserve that sort of trust.

Bluntly, if Vodafone management pursue any deal to resolve the Verizon Wireless issue then the entire Vodafone board should be sacked for venal and costly incompetence.

The best outcome would be the sale of the whole of Vodafone at a good price. (I would be happy with a combination of cash and Verizon stock.) The next best outcome is no deal at all. At least the good asset is well managed by Verizon.

But with the demonstrated record of failure of Vodafone over the past decade Vodafone has surrendered its right to make a deal - any deal - which leaves management to squander the proceeds from the best asset they have - the only asset they did not manage.




John

Alliance Resource Partners long term changes

This is the second post in my Alliance Resources series. The first post is here. 

When I get researching a company I have been known to read very old filings just to see how business has changed over time. In a case like Alliance Resource Partners this is critical. ARLP is by-far the best performed coal mining company in America and it has had the same management team since the late 1990s. The changes since that time have all be wrought by management and circumstance.

This company's record is so extraordinary that it is worth understanding it in a very long term manner.

So I started with the oldest Alliance Resources 10-K in the SEC database.

From the form 10-K for the fiscal year 1999 here are the balance sheet:

And the P&L

You will see that gross plant and equipment was $278 million with $103 million of accumulated depreciation.

Here is the production data as given from the same form 10-K.

In 1999, we produced 14.1 million tons of coal and sold 15.0 million tons of coal. The coal we produced in 1999 was 19.9% low-sulfur coal, 19.9% medium-sulfur coal and 60.2% high-sulfur coal. In 1999, approximately 85% of our medium- and high-sulfur coal was sold to utility plants with installed pollution control devices, also known as "scrubbers," to remove sulfur dioxide.

We can work out that they thus produced 2.8 million tons of low sulfur coal, 2.8 million tons of medium sulfur coal and 8.5 million tons of high sulfur coal.

The gross plant and equipment needed to produce a ton of coal was (278/14.1=) $19.7. In other words each ton of production required $19.7 worth of property plant and equipment at cost.

The above mentioned 10-K gave us some operating data as well:

In those days revenue per ton of coal was $23.12 and costs per ton was $18.75. The margin was just under $6 per ton. Maintenance capital expenditure was $6 million - or about 43c per ton of coal produced.

Depreciation, depletion and amortization was $39.7 million or $2.82 per ton.

The company also gave employment data:

EMPLOYEES 

We have approximately 1,360 employees, including 100 corporate employees and 1,260 employees involved in active mining operations. Our work-force is entirely union-free. Relations with our employees are generally good, and there have been no recent work stoppages or union organizing campaigns among our employees.

You can work out from this that each employee produced 10,367 tons of coal annually, each mine employee roughly 11,200 tons of coal annually.

To see the changes wrought we need to compare to the latest 10-K.

Here is the most recent balance sheet:

CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2012 AND 2011 (In thousands, except unit data)

		December 31,
		2012			2011
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	28,283		$	273,528
Trade receivables			172,724			128,643
Other receivables			1,019			3,525
Due from affiliates			658			5,116
Inventories			46,660			33,837
Advance royalties			11,492			7,560
Prepaid expenses and other assets			20,476			11,945
Total current assets			281,312			464,154
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost			2,361,863			1,974,520
Less accumulated depreciation, depletion and amortization			(832,293	)		(793,200	)
Total property, plant and equipment, net			1,529,570			1,181,320
OTHER ASSETS:
Advance royalties			23,267			27,916
Due from affiliate			3,084			—
Equity investments in affiliates			88,513			40,118
Other long-term assets			30,226			18,010
Total other assets			145,090			86,044
TOTAL ASSETS		$	1,955,972		$	1,731,518
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Accounts payable		$	100,174		$	96,869
Due to affiliates			327			494
Accrued taxes other than income taxes			19,998			15,873
Accrued payroll and related expenses			38,501			35,876
Accrued interest			1,435			2,195
Workers' compensation and pneumoconiosis benefits			9,320			9,511
Current capital lease obligations			1,000			676
Other current liabilities			19,572			15,326
Current maturities, long-term debt			18,000			18,000
Total current liabilities			208,327			194,820
LONG-TERM LIABILITIES:
Long-term debt, excluding current maturities			773,000			686,000
Pneumoconiosis benefits			59,931			54,775
Accrued pension benefit			31,078			27,538
Workers' compensation			68,786			64,520
Asset retirement obligations			81,644			70,836
Long-term capital lease obligations			18,613			2,497
Other liabilities			9,147			6,774
Total long-term liabilities			1,042,199			912,940
Total liabilities			1,250,526			1,107,760
COMMITMENTS AND CONTINGENCIES
PARTNERS' CAPITAL:
Limited Partners—Common Unitholders 36,874,949 and 36,775,741 units outstanding, respectively			1,020,823			943,325
General Partners' deficit			(273,113	)		(279,107	)
Accumulated other comprehensive loss			(42,264	)		(40,460	)
Total Partners' Capital			705,446			623,758
TOTAL LIABILITIES AND PARTNERS' CAPITAL		$	1,955,972		$	1,731,518

   

And here is the most recent P&L statement:

CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010 (In thousands, except unit and per unit data)

		Year Ended December 31,
		2012			2011			2010
SALES AND OPERATING REVENUES:
Coal sales		$	1,979,437		$	1,786,089		$	1,551,539
Transportation revenues			22,034			31,939			33,584
Other sales and operating revenues			32,830			25,532			24,942
Total revenues			2,034,301			1,843,560			1,610,065
EXPENSES:
Operating expenses (excluding depreciation, depletion and amortization)			1,303,291			1,131,750			1,009,935
Transportation expenses			22,034			31,939			33,584
Outside coal purchases			38,607			54,280			17,078
General and administrative			58,737			52,334			50,818
Depreciation, depletion and amortization			218,122			160,335			146,881
Asset impairment charge			19,031			—			—
Total operating expenses			1,659,822			1,430,638			1,258,296
INCOME FROM OPERATIONS			374,479			412,922			351,769
Interest expense (net of interest capitalized of $8,436, $14,797 and $888, respectively)			(28,684	)		(21,954	)		(30,062	)
Interest income			229			375			200
Equity in loss of affiliates, net			(14,650	)		(3,404	)		—
Other income			3,115			983			851
INCOME BEFORE INCOME TAXES			334,489			388,922			322,758
INCOME TAX EXPENSE (BENEFIT)			(1,082	)		(431	)		1,741
NET INCOME		$	335,571		$	389,353		$	321,017
GENERAL PARTNERS' INTEREST IN NET INCOME		$	106,837		$	86,251		$	73,172
LIMITED PARTNERS' INTEREST IN NET INCOME		$	228,734		$	303,102		$	247,845
BASIC AND DILUTED NET INCOME PER LIMITED PARTNER UNIT		$	6.12		$	8.13		$	6.68
DISTRIBUTIONS PAID PER LIMITED PARTNER UNIT		$	4.1625		$	3.6275		$	3.205
WEIGHTED AVERAGE NUMBER OF UNITS OUTSTANDING—BASIC AND DILUTED			36,863,022			36,769,126			36,710,431

   

And here is the production data:

 In 2012, we sold a record 35.2 million tons of coal and produced a record 34.8 million tons of coal, of which 3.8% was low-sulfur coal, 18.8% was medium-sulfur coal and 77.4% was high-sulfur coal. In 2012, we sold 93.1% of our total tons to electric utilities, of which 98.7% was sold to utility plants with installed pollution control devices.

Again we can work out that they produced 1.3 million tons of low sulfur coal, 6.5 million tons of medium sulfur coal and 26.9 million tons of high sulfur coal.

Note that the (high value) low sulfur coal has declined in both relative and absolute terms and this has become almost entirely a high-sulfur coal company company dependent on plants with sulfur scrubbers.

The most profound change is just how capital intensive this business has become. The company has now employed $2,362 million in gross property, plant and equipment with accumulated depreciation of 823 million.

Bluntly - the amount of capital employed here has risen enormously. The gross property, plant and equipment per ton of coal produced is now $67.87 - up a long way from $19.70 per ton.

The last 12 years in the US have not been a period of massive inflation - and the rise in capital intensity of this business is - well - surprising. The capital intensity of this business has gone up 345 percent. The capital employed per incremental ton of capacity is very large indeed.

Here are the employee numbers from the last form 10-K:

To conduct our operations, as of February 1, 2013, we employed 4,345 full-time employees, including 4,091 employees involved in active mining operations, 86 employees in other operations, and 168 corporate employees. Our work force is entirely union-free. We believe that relations with our employees are generally good.

From this we see what I think is the most unusual thing about all the giant capital spend at Alliance Resource Partners. The huge capital equipment spend has not improved labor productivity. Production is now 8009 tons per employee per year - and about 8500 tons per mining employee per year.

Despite all that capital equipment spend labor productivity has dropped by more than 20 percent. Strange.

Moreover the non-mine employees have risen from to 100 to 254 - a rise somewhat faster than the total production has grown. Labor productivity has dropped and the company has become more bureaucratic white-collar heavy.

The company also publishes a long list of operating metrics in the 10-K.

 Our historical financial data below were derived from our audited consolidated financial statements as of and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008.

		Year Ended December 31,
(in millions, except unit, per unit and per ton data)		2012			2011			2010			2009			2008
Statements of Income
Sales and operating revenues:
Coal sales		$	1,979.4		$	1,786.1		$	1,551.5		$	1,163.9		$	1,093.1
Transportation revenues			22.0			31.9			33.6			45.7			44.7
Other sales and operating revenues			32.9			25.6			24.9			21.4			18.7
Total revenues			2,034.3			1,843.6			1,610.0			1,231.0			1,156.5
Expenses:
Operating expenses (excluding depreciation, depletion and amortization)			1,303.3			1,131.8			1,009.9			797.6			801.9
Transportation expenses			22.0			31.9			33.6			45.7			44.7
Outside coal purchases			38.6			54.3			17.1			7.5			23.8
General and administrative			58.8			52.3			50.8			41.1			37.2
Depreciation, depletion and amortization			218.1			160.3			146.9			117.5			105.3
Asset impairment charge			19.0			—			—			—			—
Gain from sale of coal reserves			—			—			—			—			(5.2	)
Net gain from insurance settlement and other(1)			—			—			—			—			(2.8	)
Total operating expenses			1,659.8			1,430.6			1,258.3			1,009.4			1,004.9
Income from operations			374.5			413.0			351.7			221.6			151.6
Interest expense (net of interest capitalized)			(28.7	)		(22.0	)		(30.1	)		(30.8	)		(22.1	)
Interest income			0.2			0.4			0.2			1.0			3.7
Equity in loss of affiliates, net			(14.7	)		(3.4	)		—			—			—
Other income			3.2			1.0			0.9			1.3			0.9
Income before income taxes			334.5			389.0			322.7			193.1			134.1
Income tax expense (benefit)			(1.1	)		(0.4	)		1.7			0.7			(0.5	)
Net income		$	335.6		$	389.4		$	321.0		$	192.4		$	134.6
Less: Net loss attributable to noncontrolling interest			—			—			—			(0.2	)		(0.4	)
Net income attributable to Alliance Resource Partners, L.P. ("Net Income of ARLP")		$	335.6		$	389.4		$	321.0		$	192.2		$	134.2
General Partners' interest in Net Income of ARLP		$	106.8		$	86.3		$	73.2		$	60.7		$	45.7
Limited Partners' interest in Net Income of ARLP		$	228.8		$	303.1		$	247.8		$	131.5		$	88.5
Basic and diluted net income of ARLP per limited partner unit(2)		$	6.12		$	8.13		$	6.68		$	3.56		$	2.39
Distributions paid per limited partner unit		$	4.1625		$	3.6275		$	3.205		$	2.95		$	2.53
Weighted average number of units outstanding-basic and diluted			36,863,022			36,769,126			36,710,431			36,655,555			36,604,707
Balance Sheet Data:
Working capital		$	73.0		$	269.3		$	348.7		$	54.9		$	239.8
Total assets			1,956.0			1,731.5			1,501.3			1,051.4			1,030.6
Long-term obligations(3)			791.6			688.5			704.2			422.5			440.8
Total liabilities(4)			1,250.5			1,107.8			1,045.5			730.4			740.4
Partners' capital(4)		$	705.5		$	623.7		$	455.8		$	321.0		$	290.2
Other Operating Data:
Tons sold			35.2			31.9			30.3			25.0			27.2
Tons produced			34.8			30.8			28.9			25.8			26.4
Coal sales per ton sold(5)		$	56.28		$	55.95		$	51.21		$	46.60		$	40.23
Cost per ton sold(6)		$	38.15		$	37.15		$	33.90		$	32.23		$	30.39
Other Financial Data:
Net cash provided by operating activities		$	555.9		$	574.0		$	520.6		$	282.7		$	261.0
Net cash used in investing activities			(623.4	)		(401.1	)		(295.0	)		(320.1	)		(184.1	)
Net cash provided by (used in) financing activities			(177.7	)		(238.9	)		92.7			(186.6	)		166.8
EBITDA(7)			581.1			570.8			499.5			340.4			257.8
Maintenance capital expenditures(8)			282.6			192.7			90.5			96.1			77.7

We can work out a few more things here - for instance the maintenance capital expenditures are now 282.6 million dollars annually. That is $8.12 per ton produced per year. Back in 1999 maintenance capital expenditure was only 43c per ton produced per year.

That is an 18 fold increase in maintenance requirements per ton produced per year.

An unmitigated record of operational failure

This is very puzzling indeed. Financially this is the best performed coal operation in North America - the stock price is near the all time high. The distributions paid by this MLP are large and increasing. People sing the praises of this management team (particularly on Seeking Alpha but also in the comments on my blog).

But the operational facts on the ground tell a radically different story. This management team demonstrate unparalleled operational failure. The company has radically increased its capital expenditure - and the capital intensity of the business has gone up roughly 350 percent. This is a big-spending management team.

Despite that (and despite their non-unionized workforce) labor productivity has dropped more than 20 percent. And the workforce has become more bureaucratic.

Finally all this new - and seemingly expensive machinery - needs to be maintained. And the maintenance expenditure which was once only 43c per ton per year (less than 2 percent of the price received per ton of coal) is now over $8 per ton of output (over 14 percent of the price received per ton). This business is way more expensive to maintain.

On an operational level this is seemingly the worst run mining operation in the United States (and I am including the bankrupt Patriot Coal). And yet the company has had unparalleled financial success.

Why this might be is the subject of a few more posts.






John