Natural Resource Partners LP (NYSE:NRP)
Click to enlargeInvestors searching for high dividend income may be attracted to NRP (8.0% Yield) but it would be prudent to understand their business model, which stacks the deck in favor of the General Partner (including affiliates) at the expense of Limited Partners.
A general description of the company is as follows:
Natural Resource Partners L.P. is a limited partnership formed in April 2002, and we completed our initial public offering in October 2002. We engage principally in the business of owning and managing coal properties in the three major coal-producing regions of the United States: Appalachia, the Illinois Basin and the Western United States. As of December 31, 2009, we owned or controlled approximately 2.1 billion tons of proven and probable coal reserves. We do not operate any mines, but lease coal reserves to experienced mine operators under long-term leases that grant the operators the right to mine our coal reserves in exchange for royalty payments. Our lessees are generally required to make payments to us based on the higher of a percentage of the gross sales price or a fixed price per ton of coal sold, in addition to minimum payments.
Besides the interests of the General Partners and the publicly traded Limited Partner units, “Holders of Incentive Distribution Rights” are getting a nice piece of the pie doled out by NRP. The distributions to Limited Partners increased from $1.88 per LP Unit in calendar 2007, to $2.07 in 2008, $2.16 in 2009 and continued at the rate of $0.54 a quarter in the first two quarters in 2010.
An 8% dividend yield sound pretty good in this ultra-low rate environment, but if things sound too good it's time to become cautious. During the same periods the Net Income allocated to each Limited Partner Unit amounted to $1.11 in calendar 2007, $1.95 in 2008, $1.17 in 2009 and $0.63 for the six months ended June 30, 2010. It can be seen that distributions to Limited Partners exceeded the amounts of Net Income Allocated to Limited Partners. Below are the totals of Net Income Allocated along with the Distributions to the various interests in NRP for the calendar years 2007-2009.
There is a strong incentive for the General Partner to make maximum distributions to Unit Holders since this increases the General Partners overall share of allocated net income and distributions as explained below.
The 2010 Form 10K spells out the distributions arrangement called for under the limited partnership agreement as follows:
Our general partner holds 65% of our incentive distribution rights (IDRs) and the remaining IDRs are held by affiliates of our general partner. The IDRs entitle the holders to incentive distributions if the amount we distribute with respect to any quarter exceeds the specified target levels shown below:
We must distribute all of our cash on hand at the end of each quarter, less cash reserves established by our general partner. We refer to this cash as “available cash” as that term is defined in our partnership agreement. The amount of available cash may be greater than or less than the minimum quarterly distribution. Provisions of our credit facility and note purchase agreement may restrict our ability to make distributions under certain limited circumstances.
In general, we intend to increase our cash distributions in the future assuming we are able to increase our “available cash” from operations and through acquisitions, provided there is no adverse change in operations, economic conditions and other factors. However, we cannot guarantee that future distributions will continue at such levels.
The higher the dollar amount of the distribution paid, results in the Limited Partner getting a lower share (percentage-wise) and the holders of the IDR's getting a higher share (percentage-wise) of total distributions and allocated net income (see table above). The percentage of the Partnership’s total Net Income allocated to Limited Partners declined from 75% in calendar 2008, to 69.2% in 2009 and dropped further to 62.6% in the six months ended June 30, 2010. During the same period the holders of the Incentive Distribution Rights saw their percentage allocation of the partnership’s total net income increase from 23.5% in calendar 2008 to 29.4% in 2009 and 36.2% in the six months ended June 30, 2010.
For additional info, click here for the NRP's worksheet to see operating results, balance sheet data and various other metrics for the years 2005-2009 and the first two quarters of 2010.
I’m all for incentivizing a company’s management with rewards to achieve above average operating results but I am dubious of measuring performance by uncharted metrics (“available cash”) buried inside of a Partnership Agreement rather than old fashioned metrics like net income. While capturing an 8% dividend yield, in an ultra-low rate environment, is noteworthy there should be some concern over the disconnect between the cash distributions made versus allocated net income amounts for the Limited Partners versus the holders of Incentive Distribution Rights (IDR’s).
On September 20, 2010 NRP eliminated the Incentive Distribution Rights reporting it as follows:
As consideration for the elimination of the IDR's , Natural Resource Partners has issued 32 million common units to the holders of the IDRs. NRP now has 106,027,836 common units outstanding and the general partner will retain its 2% interest in Natural Resource Partners.
It would not be surprising for some limited partners to be scratching their heads and wondering whether the $832 million (32 million common units at $26 a unit) received by the holders of the IDR's was fair and reasonable or chicanery. As I understand it there is a close relationship between the interests of the IDR's and the General Partner.