I've written about a dozen articles on coal MLPs Alliance Resource Partners (ARLP) and Natural Resource Partners (NRP). In December, I said that the units of these two companies had become oversold on unwarranted fears of the fiscal cliff. From their lows in December through Friday, Jan. 25, Alliance and NRP are up 29% and 19%, respectively.
Even though the upside from here is less exciting, I still like both of these companies a lot. Alliance remains far and away the safest and most profitable coal producer in the U.S., and it has a 6.8% yield! In this article, I discuss the latest developments at NRP.
Natural Resource Partners L.P. reported that it has acquired a 48.51% general partner interest in OCI Wyoming, 20% of the common shares and all of the preferred shares of OCI Wyoming from Anadarko. NRP paid a net $292.5 million for the interests. The acquisition was funded through a $200 million term loan, the issuance of $76.5 million in equity, including a general partner contribution of $1.5 million, and $16 million in cash.
NRP expects to receive an annual preferential distribution of $4.7 million on its preferred shares in OCI Wyoming. NRP expects the transaction to be accretive to cash flow in 2013 in a range of $0.18 to $0.22 per unit.
Still Plenty of Room for Improvement
Since NRP's low unit price in mid-December, the yield on the units has fallen from 12.7% to 10.0%. Given the above-mentioned acquisition, I believe that the yield investors demand to own NRP will continue to decline, (and the unit price continue to climb). As the company diversifies further from coal-related revenues, the business risk is declining. NRP is rapidly approaching the risk levels of more traditional energy-related MLPs yielding 4%-7%.
Assuming that NRP's annual distribution stays steady at $2.20 and the required yield demanded by investors falls to 7.0%, 7.5%, or 8.0%, that would equate to a unit price of $31.43, $29.33, or $27.50, respectively. Today's current yield of 10% plus the capital appreciation implied by those required yield hurdles of 7.0%-8.0% would generate total one-year returns of 51%, 41%, or 33%, respectively.
8% Yield Achievable by Year-End, 33% Total Return
Most energy-related MLPs are trading at yields of 4%-7%. NRP's yield is 10%. I've been saying for the past year that NRP's business model is not as risky as investors believe. Still, there are two main reasons why investors shun NRP. First, the company is incorrectly thought to be a coal producer, and coal market fundamentals are dismal. Second, NRP is not earning its distribution. Investors assume that NRP will have to cut its distribution, or keep it unchanged indefinitely, even borrowing funds to maintain it.
Diversification Away From Coal Continues
With the Wyoming soda ash acquisition, the first concern should be put to rest. Yes, NRP has a lot of exposure to coal, but it has made numerous non-coal related acquisitions over the past three to four years. Pro forma for this acquisition, 39% of 2012 revenues would have been from non-coal royalty sources, including aggregates and industrial minerals, oil and gas, and "other." 13% of that 39% of non-coal royalty revenues are still associated with coal, but come from infrastructure, transport, and processing fees. This bucket of revenue is more volatile than oil and gas pipelines, but less volatile than straight coal royalties.
Turning to the legacy coal royalties, 27% comes from coking coal, 20% from Central Appalachian thermal coal, and 14% from the Illinois Basin/Northern Powder River Basin. I believe that a good portion of these coal royalties remain high quality sources of revenue. For example, many of NRP's coal producer lessees have long-standing relationships with investment grade, regulated utilities.
39% of Pro Forma Revenues Completely Unrelated to Coal
The weighed average yield from these four buckets is 7.97%. Assuming NRP units trade at that yield a year from now, the total return would be 33%. I think this is a very reasonable outcome. In the event that coal markets turn around in 2014, I think the company-wide required distribution yield demanded by investors to own NRP could fall to 7% and the distribution increase by say 2.5%. Then, over the next two years, an investor could get a 64% total return by clipping the 10% current yield for two years and from capital appreciation of the units from $22.34 to $32.21.
NRP Much Less Risky Than Coal Producers
While it's entirely possible to achieve greater returns in coal producers like Walter Energy (WLT), Alpha Natural Resources (ANR) and Peabody Energy (BTU), those stocks have far greater volatility and those companies struggle with dangerous levels of debt. Each made top-of-the market acquisitions in 2011. I believe that NRP is far less risky than Walter, Alpha, and Peabody, yet offers similarly compelling total return potential.
If one believes that coal market fundamentals have bottomed, then an investment in Alliance and NRP makes a great deal of sense. Investors in NRP should not expect any distribution growth in 2013 or perhaps into 2014. As investors regain confidence in NRP's business model, the unit price could increase significantly and distributions could start to grow by 2%-4% sometime in 2014. NRP is lower risk then it was a year ago and will be lower risk next year than it is today. 10% yields are harder and harder to come by. This 10% yield could be moving a lot lower in the coming months.