Natural Resources Partners: 9% Yield And A 22% Total Return Opportunity

| About: Natural Resource (NRP)

Every day on SeekingAlpha there are articles about high-yielding stocks that should be bought. Most, but probably not all, readers recognize that the highest yielding stocks are frequently at risk of dividend or distribution cuts. MLPs are well-covered on this site, and they typically have yields in the 5%-8% range. One 9% yielding MLP that's almost certainly NOT at risk of a distribution cut is Natural Resources Partners, (NYSE:NRP).

NRP is NOT a coal producer, but NRP's unit price has been under pressure because ~74% of the Company's royalty revenues come from lease payments of coal producer customers. Historically, this revenue stream has been steady and reliable. However, given what's happened to other coal producers, investors assume that NRP must be suffering mightily as well. Yet the yield cushion of 9% from an annual distribution of $2.20 on a unit price of $24.4 is quite protective on the downside.

NRP has been conservative and prudent in its distribution policy. Existing unitholders have not benefited from a rising distribution rate, but an investment in the units at the current price offers compelling risk / reward, as growth prospects starting next year look to be promising. NRP unitholders should not expect to see a cut in their distribution. Even though conditions in the coal space are terrible, and have been for months, NRP's coal customers have committed and priced contracts for 2012. This should enable NRP to receive royalties on an increasing amount of attributable production.

While the rest of the coal sector players like Arch, (ACI), Peabody (BTU), Alpha (ANR), Patriot (PCX), Consol (NYSE:CNX), James River (JRCC), Cloud Peak (NYSE:CLD) and Walter Energy (NYSE:WLT) are cutting production left and right, NRP's customers are increasing production year-over-year. Guidance is for an increase in royalty paying tonnage of 8%-9% in 2012. While, in normal times, contracted tons are pretty much written in stone, these are not normal times. Coal fundamentals have turned ugly, and it happened very quickly. As a result, there's a real possibility that coal producing clients will experience pushback on their contracted tons. And of course, lower coal prices will be a drag on NRP's revenues.

There's no secret as to why the coal market is suffering. A very mild winter, slowing growth in China, a likely recession in Europe and decade low natural gas prices have created a perfect storm. Unfortunately for coal prices, that perfect storm was not over eastern Australia this year. [last year severe flooding in Queensland Australia caused coking coal prices to spike]. Benchmark quarterly coking coal prices are down almost 38% from mid-2011. Even if NRP's attributable coal production grows less than 8%-9% this year, the Company's distribution will not be at risk for one simple reason, liquidity.

At 12/31/11, NRP was sitting on cash of $215mm + full availability on a $300mm credit facility maturing in 2016. Earlier this week, NRP announced an acquisition for $59mm that will be, "immediately accretive and will add approximately $7.5 million to $8.5 million in additional cash flows to NRP's 2012 distributable cash flow." More important, NRP has an excellent opportunity to make additonal accretive acquisitions. Why? Because almost everyone's a seller, and NRP is a buyer. Patriot, Alpha, James River and Arch are probably sellers of reserves in this depressed environment. Among private producers, asset sales are now a matter of life or death. NRP will have the pick of the litter and at favorable valuations.

So far, I've argued that NRP's 9% yield is safe, but investors want to see growth. I'm assuming that investors will not enjoy an increase in the distribution this year, but that the rate will increase by 5% in both 2013 and 2014. The reason I'm not suggesting that growth will be 5% forever is that growth could easily be higher than 5%. One reason for higher growth is that 26% of the Company's revenues come from non-coal sources. These revenues diversify away from coal somewhat, but they also offer the opportunity for more robust growth.

The best example is NRP's 51% ownership in a joint venture with International Paper, (NYSE:IP). This deal has been flying under the radar screen because management has been busy acquiring assets and getting all manner of permits and approvals on 9mm potential resource bearing acres. NRP contributed $42mm to the joint venture 2 years ago and is currently receiving a minimum $4.25mm distribution from the venture. This amount could grow substantially, more than 5% per year, once the blocking and tackling is done and the marketing of the assets picks up.

Another example comes from NRP's aggregates business. At some point, the housing market will rebound and the rebound might be robust. NRP's attributable aggregates reserves are valuable but under-utilized. In a year or two, both pricing AND volumes in aggregates could be growing above 5% per year. Collecting a current yield of 9% is attractive for a company with limited downside, a strong balance sheet and good growth prospects beginning in 2013.

To be clear, I'm not in this for only 9%. Instead, I expect NRP to prove itself as a high yielding, low risk company. I believe that the yield on the units will fall to 8% within 1 year, implying a unit price of $27.5. Capital appreciation from $24.4 to $27.5 would provide a return of ~13%. Add to that the 9% current yield, and an investor today might enjoy a total return of 22% over the next 12 months. One could then expect a 13% return in 2013 and 2014, (8% yield + 5% distribution growth). However, that 13% return could have upside if growth comes in above 5% as discussed earlier.

With the strong start to 2012, some believe that a market pullback is imminent. I would not be surprised to see a pullback, but I'm not predicting one. I do think that gains over the next 12 months will not continue at the current pace. Unless the market rallies a further 20%-30% from here, NRP will likely be a solid investment choice and one that could outperform nicely on in a down market.

Disclosure: I am long (NRP), (OXF), (ACI), (PCX), (CNX), (BTU), (ANR). I bought units of both NRP and OXF on Tuesday (3/6/12)