Natural Resource Partners
Natural Resource Partners L.P. (NYSE:NRP) is a master limited partnership that owns and manages mineral properties. NRP does not actively engage in mining minerals or natural resources, but rather leases its properties to various operators in exchange for royalty payments.
I am long NRP in my Retirement Income Portfolio.
In articles about this portfolio, the securities are listed in order according to the number of consecutive years of dividend or distribution increases. NRP grew its distribution each calendar year since 2004, even though in recent years the increases were very small. The "streak" ended on 12/31/13, and NRP dropped down to near the bottom of my spreadsheet.
In light of no 2013 distribution increase, I entered the new year viewing NRP as a possible source of funds for other purchases. NRP has been the portfolio's only security in the materials sector. On 12/31/13, I bought shares of Rayonier (NYSE:RYN) as a second holding in the materials sector, thinking that this timber REIT could eventually replace NRP as the materials representative in the portfolio.
Some dividend investors automatically sell a holding if the firm fails to raise the dividend or distribution each year. I have been impressed with the way NRP's management has tried to reposition the partnership in a very difficult coal market, so I did not automatically sell NRP, but it entered 2014 on my (negative) watch list. NRP's closing price on 12/31/13 was $19.94. My target "sell" price was $23.99.
Anatomy of a Distribution Cut
NRP's closing price was $20.34 on January 9, 2014. After the close, NRP issued a press release announcing its Q4 2013 distribution of $.35 per unit, down from $.55 per unit, a 36% reduction.
Nick Carter, President and COO, said, "We did not see the recovery in the coal markets that we thought might occur over the course of 2013, but instead the markets weakened. As we approached the end of the fourth quarter, we gained more clarity on our lessees' operating plans for 2014. Based on the information received from our lessees, we determined that our forecast for 2014 coal-related revenues, and as a result, distributable cash flow, will be significantly lower than our previous estimates. This led NRP's management to recommend a distribution reduction to the Board of Directors."
NRP reaffirmed earlier guidance for 2013 results, stating that diversification into soda ash, oil and gas largely offset the decline in coal-related revenues in 2013. NRP completed over $350 million of non-coal-related acquisitions in 2013.
NRP management believes that the distribution decrease "will enable the partnership to reduce its debt while preserving its liquidity to pursue accretive acquisitions." NRP remains committed to its strategy to diversify its asset base. Based on the 2014 guidance included below and an annualized distribution at the quarterly distribution rate declared today, NRP expects that its distribution coverage ratio for 2014 will be between 1.24x and 1.47x.
Management stated that "coal markets continue to be uncertain, and prices for both steam and metallurgical coal continue to be depressed. With the expectation that the challenges that have affected the coal markets over the last two years will continue through at least 2014, and despite NRP's solid operating and financial performance in 2013, the Board of Directors has decided to lower NRP's quarterly distribution to a level that it expects can be sustained until the coal markets recover."
From the press release: "At December 31, 2013, NRP had approximately $390 million of liquidity, with $93 million in cash, $280 million available for borrowing under NRP (Operating) LLC's $300 million revolving credit facility and the full $16 million available for borrowing under the NRP Oil and Gas LLC revolving credit facility. Other than $81 million in principal repayments due each year for the next several years on NRP Operating's senior notes, NRP does not have any debt maturing until 2016, and NRP expects no covenant compliance issues over the next year."
NRP's website lists four business strengths:
Stable, Predictable Cash Flow through leases that provide for royalty rates generally equal to the higher of a percentage of the gross sales price or a fixed price per ton for coal and aggregates mined, subject to a minimum payment. In addition most leases require a minimum payment either on an annual or quarterly basis. This structure generally allows production and cash flow to be stable and predictable in periods of low commodity prices, while enabling NRP to benefit during periods of higher commodity prices.
Experienced Lessees with a Diverse Customer Base of over 70 lessees, many of which are large public companies. They sell to a diverse group of utilities, steel companies and industrial users.
Strategically Located and Diverse Reserves that are geographically diverse and include coal, aggregates, as well as oil and gas. NRP lessees mine both metallurgical and steam coal which are marketed to a diverse customer base, enabling lessees to adjust to changing markets and sustain sales volumes and prices.
Experienced Management Team with a successful record of managing, leasing and acquiring properties in the areas in which lessees mine. Management understands the mining environment and trends in the industries. Management's strengths include the necessary skills and experience to identify and integrate future acquisitions.
From its inception, NRP has seen aggregates as a natural expansion of its business model.
In addition to the royalty business, NRP also owns coal preparations plants, beltlines for transporting coal, coal load-out facilities and a fire grind aggregates facility.
The Partnership's Business Model
Natural Resource Partners was formed in April 2002 with selected properties from several sources. In the beginning, 45% of NRP reserves came from properties formerly owned by CSX Corporation located in West Virginia, Kentucky, Maryland, Indiana and Alabama.
40% of NRP's original reserves came from properties formerly owned by Arch Coal located in West Virginia, Kentucky, Illinois and Virginia.
14% of NRP's original reserves came from properties formerly owned by Burlington Railroad in Montana. 1% of NRP's original reserves came from properties in West Virginia formerly owned by New Gauley Coal Corporation.
NRP primarily owns U.S. coal, aggregate, oil and gas reserves that generate royalty income. NRP is the fifth largest owner of coal reserves in the U.S., with 2.4 billion tons. For the twelve months ending 9/30/13, NRP properties produced 59.2 million tons of coal and coal royalty revenues of $232.6 million (63.6% of $365.8 million total revenues).
In a November 13, 2013 presentation at Jefferies' 2013 Global Energy Conference, Executive VP Wyatt Hogan pointed out that NRP's total revenues grew from $159.1 million in 2005 to $365.8 million in the 12 months ending 9/30/13.
New Revenue Streams
|Steam (Appalachian) Coal||$86M||54%||$66M||18%|
|Steam (Illinois Basin) Coal||$5M||3%||$56M||15%|
|Infrastructure, ORRI, Minerals||$6M||4%||$56M||15%|
|Oil & Gas||$3M||2%||$12M||3%|
Steam (Powder River Basin) Coal
|Aggregates & Industrial Minerals||none||0%||$34M||9%|
Management believes NRP properties have 500 million tons of aggregates in 13 states.
Hogan said he believes the Illinois Basin is the future of NRP's coal business. U.S. thermal coal production outlook for the next decade is for Illinois Basin coal to grow by 45%, for Powder River Basin coal to grow by 33%, and for Appalachian coal to decline by 25%. Advantages of Illinois Basin coal include its low cost position, efficient export access (via the Mississippi River), high heat content, and lower regulatory/environmental issues.
Even though the price of metallurgical coal peaked around $335 a ton in 2011, and has declined to around $150 a ton by late 2013, NRP has been able to maintain its EBITDDA margins at 87% or 88% from 2011 through the twelve months ending 9/30/13. EBITDDA for 2011 was $330 million; for 2012 was $328 million; and for the last twelve months ending 9/30/13, it was $322 million.
Coal royalty income for 2011 was $279 million (74% of $378 total revenues); in 2012 it was $261 million (70% of $379 total revenues); and for the last 12 months ending 9/30/13, coal revenues were $233 million (64% of $366 total revenues).
In June, 2010, NRP and International Paper (NYSE:IP) formed a joint venture to own and manage more than 9.1 million acres previously held by International Paper. NRP paid $42.5 million and has annual cumulative preferred distribution of $4.25 million and 51% of any excess income.
In January, 2013, for $292.5 million, NRP acquired Anadarko's (NYSE:APC) 49% interest in OCI Wyoming, which consists of trona ore mining operations and a soda ash refinery in Wyoming. Through September, 2013, NRP had received $22.2 million in revenue and $72.9 million in cash distributions. OCI Wyoming produces about 20% of the soda ash made in the U.S. The three largest business uses for soda ash are glass (48%), chemicals (29%), and soaps and detergents (8%).
NRP's diversification strategy includes a growing percentage of oil and gas properties. NRP owns over 494,000 net leased oil, gas and coal bed methane acres, with more than 1,000 producing wells. Recent acquisitions include $64 million for 19,200 net mineral acres in Oklahoma, $30 million for Marcellus Shale override royalty interests, $38.3 million for non-operating working interests in the Bakken/Three Forks.
Guidance for 2014
NRP's press release stated: "As a result of lower expected pricing and production volumes, coal royalty revenues are projected to decrease by $28 million as compared to the 2013 guidance range. The reduced coal royalty revenues, together with increased interest expense related to NRP's 9⅛% senior notes issued in September, result in a substantial decrease in projected distributable cash flow as compared to projected distributable cash flow for 2013 (excluding the $44.8 million special distribution received from OCI Wyoming in July)."
|Range in Millions|
|(except per unit)|
|Coal-related revenues||$205.0 to $230.0|
|Coal royalty revenues||$175.0 to $195.0|
|Coal production (mm tons)||43.0 to 50.0|
|Aggregates & industrial minerals||$47.0 to $52.0|
|Oil and gas revenues||$37.0 to $41.0|
|Total revenues||$305.0 to $340.0|
|Distributable cash flow||$195.0 to $230.0|
|Net income per unit||$1.10 to $1.30|
The Day After the Distribution Cut
Seeking Alpha alerted me to the press release. Early on the morning of January 10, I jotted down four scenarios to discuss with my wife over breakfast:
1) Do nothing.
2) Sell NRP and buy more RYN (which is selling not far from its 52-week low and far removed from its 52-week high, and at a high yield compared to its history).
3) Sell NRP and buy PG (which has been on my "shopping list" and would move consumer staples to a 10% allocation, but PG is selling much nearer its 52-week high and at an historically high PE ratio).
4) Sell NRP and buy more RYN and a half-allotment of PG.
We also discussed a fifth option: Sell NRP and hold the cash.
I felt like Friday, January 10 would be the worst time to sell, unless we could sell early before all the retail customers heard the news. There was one brief moment Friday morning in the first 10 or so minutes of trading when the price was bouncing around like crazy. It was $17.97, then up to $18.90, but before I could pick up the phone, it was at $18.05. Then it dropped rather quickly to $17.00. It seemed to find some support around $17.00, but it closed on January 10 at its low of the day (which isn't good) at $16.60.
I decided at 8:45 on Friday morning that I would do nothing. So, I entered the weekend still holding NRP. I'm not willing to sell at Friday's prices, based primarily on one line from the press conference: "the Board of Directors has decided to lower NRP's quarterly distribution to a level that it expects can be sustained until the coal markets recover." The management is well-respected by others in the industry and I believe they operate with integrity.
It would not surprise me to see NRP trade between $14.00 and $17.50 during this quarter. (That would represent a yield of between 8.0% and 10.0% on an annual distribution of $1.40.) I think NRP is well-run, but they have not been able to diversify from coal fast enough (into oil properties, etc.) to avoid a distribution cut. For now I'm content to live with the reduced payout and see how the quarter, and perhaps the year, unfolds.
If I had sold NRP when they failed to raise the distribution by year-end, I would have escaped the distribution cut and Friday's big drop. Score one for adhering to a hard-and-fast sell rule.
Almost everyone who has written about NRP in the last two years has noted the risks involved with the very depressed coal market, so in many ways this distribution cut was not surprising. Still, I went back over previous articles and NRP statements to see if I had "missed" something.
Two company presentations in November (Jeffries, cited above, and at Cowen) gave no hint of a distribution cut. In fact, in the Jeffries presentation, Executive VP Wyatt Hogan cited NRP's financial reserves of $100 million in stating that the company would be able to grow its distribution.
NRP does not hold quarterly conference calls. As I consider companies for future purchases, I will be reluctant to invest in a firm that does not engage stakeholders and the investment community on a quarterly basis. Quarterly conference calls give an investor an important window into the enterprise and management.
This episode also underscores the importance of diversification. The distribution cut is a disappointing annoyance. One year ago, these events would have been much more painful. At that time, NRP was 7.6% of my Retirement Income Portfolio. 2013 was a year of diversification for the portfolio, of which NRP is now just 2.4%
I offer this reflection not as a recommendation to buy or sell NRP or any other security. The events surrounding NRP's distribution cut have been a learning experience for me and I share this with the SA community as part of our mutual market laboratory.