An article on Natural Resources Partners, LP (NRP), a Master Limited Partnership, from another SA contributor hit the tape Tuesday morning, here. In it the author states some interesting facts, but is not forceful enough about some key attributes of the investment.
Before going any further, if one believes that coal is doomed, then an investment in NRP or my other favorite Alliance Natural Resources, LP, (ARLP) is not a good idea. Readers know my view on Alliance, I'm a huge fan. See my latest piece, here. Coal fuels close to 40%'s of electricity generation, it can not be phased out quickly or easily. Nuclear and natural gas cannot pick up the slack and renewables cannot provide reliable base load capacity.
As a reminder, here's a description (paraphrased) of the company's business from NRP's latest 10-Q filing of November 6th,
NRP engages in the business of owning, managing and leasing mineral properties in the U.S. NRP owns 2.3 billion tons of proven and probable coal reserves in the three major coal-producing regions of Appalachia, the Illinois Basin and the Western U. S. and 380 million tons of aggregates. The company does not operate any mines, but leases reserves to experienced mine operators under long-term leases.
Most of the leased coal is produced by large companies with experienced and professional sales departments. A significant portion is sold under long-term contracts. In the coal and aggregates royalty business, NRPs lessees make payments based on the greater of a percentage of gross revenues or a fixed royalty per ton, subject to minimum payments.
The above two paragraphs reveal important parts of the NRP story. First, the company does not mine any minerals. Therefore NRP is not exposed to things like cost inflation, permitting or labor issues. Second, The company owns 2.3 billion tons of coal reserves, making it a top-3 owner of coal reserves in the U.S. Third, minimum royalties are paid by lessees, mitigating reduced volumes and pricing.
This non-producing natural resources business model is essential to the value proposition. Not only is NRP largely immune from cost inflation, it actually benefits because over time, coal prices must increase along with costs in order to sustain margins. Alpha Natural Resources, (ANR), Arch Coal, (ACI) and Peabody Energy, (BTU) are not so lucky. As they shrink to balance industry supply and demand, unit costs are rising.
While NRP's lessee coal volumes are down, cash flow is holding up relatively well. In part due to the minimum royalties paid by lessees and more importantly to growing cash flow from non-coal related sources. A fact that I've tried to convey, but is hard to quantify, is that NRP has made significant acquisitions in 2010-2012. Even in trying times, the company is making acquisitions.
Collectively, these acquisitions have not fully come online, not even close. So as coal royalties languish through 2013, non-coal revenues will be up on both an absolute and relative basis. This does not mean that NRP will be raising its distribution anytime soon, but that they can maintain the $2.20 per year, which is a current yield of 12.6%.
Question, if you could be highly confident that NRP will maintain a $2.20 annualized distribution for at least the next eight quarters, would you buy the units? As of September 30, 2012, NRP had $122 million in cash and $197 million of available on its credit facility, for total liquidity of $319 Assume that NRP burns $10 million more per quarter then the actual cash distributed. After eight quarters the cash cushion would fall from $122 million to $42 million. At a $15 million quarterly burn rate, cash would fall to $2 million.
Arguably we are in the worst part of the coal market depression. Even in this environment NRP is not burning anywhere near $15 million per quarter. In an equity research report dated 11/13/12, the analyst forecasts a total CY 2012 burn of $10 million, an annual burn of $20 million in 2013 and $30 million in 2014. That's $60 million of cash burn in excess of actual distributions paid through 12/31/14 vs. cash and bank availability of $319 million. And remember, NRP can borrow to make distribution payments as the company still has ample room under its debt covenants.
It's important to recognize that since 2003, NRP has generated $200 million of cash in excess of distributions paid. This cash, sales of units and borrowings on the company's $300 million credit lines have allowed the company to make acquisitions for growth. Dialing back cap-ex would bolster liquidity even further.
Sellers of the units at today's levels are not appreciating the balance sheet liquidity enjoyed by NRP. Sellers are assuming that coal producers are doomed and like peer coal MLPs Oxford Resource Partners, (OXF) and Rhino Resource Partners, (RNO) NRP will be forced to cut distributions. This simply is not borne out by the numbers. In my opinion, NRP has at least eight quarters to go before a distribution cut might be necessary, if at all.
At a current yield of 12.6%, investors are being paid to wait for an eventual turn around in coal markets. If coal markets never rebound from today's sorry state, then an investment in NRP might prove to be a bad one. However, even a modest improvement in coal and continued growth in NRP's non-coal cash flows could get the company back on track for distribution growth, albeit probably not this year or next.