Does Dividend Giant Natural Resource Partners Deserve A Second Look?

| About: Natural Resource (NRP)

In an unpredictable macroeconomic environment, the best investment choices are often high yielding dividend stocks. High yielding dividend stocks with safe betas are terrific investment decisions in an unpredictable market because, assuming the financial markets avoid substantial losses, the investment will at least keep pace with inflation.

Natural Resource Partners (NRP) is a stock that falls into this category. NRP yields an 8.8% dividend with a beta of 0.94. Please note that a beta below 1 illustrates that the particular stock is less volatile than the broader market. Unfortunately, NRP has not performed as well as the beta suggests. In 2011, NRP's share price declined 18%. Taking into consideration dividends, investors lost 11% - which is not good.

While 2011 has passed, there are a few obvious reasons as to why NRP's share price declined in 2011. The primary culprit is asset impairment. Impairment caused the company's income to drastically decrease during the third and fourth quarter. In fact, over the third and fourth quarter of 2011, the company did not turn a profit. The argument I will make is whether the stock will continue to depreciate, or if this is a terrific buying opportunity. The main point I will make is an in-depth look at the firm's income statement and balance sheet to determine if there are any underlying problems with the business itself.

Briefly, NRP focuses on collecting royalties from company's that lease NRP-owned land. Instead of mining for commodities, NRP simply leases the land and collects royalties. One positive about this business model is that mining will continue to grow regardless of broader economic situations. Therefore, NRP will always have a market. The biggest issue with NRP, and any mining company, is that if end-demand for a certain commodity decreases or an increase in supply saturates the market, the price will decrease. Therefore, mining for that particular commodity will decrease and NRP will find it difficult to lease a lot with a commodity that has a very low price. Coal is a perfect example of this.

Income Statement and Balance Sheet

Beginning with NRP's income statement, we see that NRP is a very strong company. As you can see in the chart below, revenue and coal revenue have increased since 2002. Net income on the other hand has not. But looking more closely into the income statement we see that "asset impairment" is the culprit. It appears NRP had to write down about $161 million in impaired assets; $90.9 million in the third quarter and $70.4 million in the fourth quarter.

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Diving into NRP's 10-Q (page 9) from November 8, 2011, we find the reason for this impairment. According to the filing, during the third quarter one of NRP's clients (Gatling LLC) indicated to NRP that they do not expect to see any future gain from a mine in West Virginia. At the time, the mine had a fair value of $8 million and a book value of $126 million. After subtracting for received payments and future payments yet to be received at the time, the impairment charge is $90.9 million. That takes care of the third quarter, so now let us look into the fourth quarter.

Similarly, NRP states in the firm's 10-K (page 62-63) that Gatling Ohio LLC reported that one of their mines became uneconomical and no future cash flows are expected to come from it. At the time, the net book value of the property was $93.4 million and the fair value was only $22.9 million. This leads to the $70.4 million impairment charge written down in the fourth quarter.

There are two polar trends that need to be discussed concerning these impairment charges. The first is the bullish case. Since these impairment charges are simply one-time, it is very likely that NRP will see a vast increase in net income in 2012. The bearish case is that more mines will continue to become abandoned and future impairment charges will take place. Not only will this scenario lead to substantially lower income, but at some point if more mines shut down NRP will lose revenue. To add insult to injury, both mines are coal related; which is NRP's big revenue producer.

Which scenario is more likely to come to fruition? At this point in time I am siding on the more bullish situation. While two mines coming to a stop at the same time is concerning, I believe that coal prices will begin to come back around and production will increase at some point. When this will happen is unknown, so I will avoid any predictions.

Another factor worth mentioning from NRP's income statement is interest expense. The firm's interest expense has increased steadily since 2002. This is also a double-edged sword. On the one hand, increasing interest expenses indicate that the firm is paying the interest on their debts; which indicates a strong financial background. On the other hand, it indicates that the firm is relying on more debt to finance operations; which is confirmed by NRP's scary long term debt to assets ratio since 2002 as seen below.

NRP's long-term debt to assets ratio is important to note because it paints a clear picture that NRP is financing its operations with long-term debt. To be frank, if NRP's share price followed the firm's long-term debt to assets graph then investors would be extremely satisfied.

The interesting aspect of this discussion is that NRP currently holds almost $215 million in cash and cash equivalents. This indicates that NRP has the funds to pay off a substantial portion of debt, but the firm elects otherwise. In fact, NRP's cash position has increased 268% since 2007. This is incredible growth and it indicates that NRP will not be suffocated by debt. On the other hand, it is easy to let long-term debts build up into a mountain and then push the debts under the rug just as ________ (you fill in the blank with any country you want and you will be the winner).

Anyways, with that pent-up frustration out of the way, we can get back to discussing NRP's prospects. In review, NRP's revenues are impressively increasing, but due to two disastrous impairment charges the firm's income faced severe weakness. This does not mean NRP is a definite buy though. Operating income has also weakened. NRP's operating income in 2011 retraced back to 2005 levels. Before jumping ship, please keep in mind that operating income was hindered by the same $161 million impairment charge. Therefore, NRP may have delivered record operating and net income if not for the two mines.

Share Price

Let us now turn to the share price. One of the most frustrating aspects of dividend investing is owning a stock that does not make up for stock price losses with the dividend. Now, since NRP has an 8.8% dividend the stock price has some leeway, but not much. After reaching a high in March of 2011, the stock has not been able to find any resistance on the way down. Right when investors thought 24.20 was a strong resistance point, the stock fell through in early March 2012.

As you can see the stock broke down below the previous floor in early March and broke through again three weeks later. This indicates that the stock has not stabilized and investors should be weary in the near term.

Buy, Sell, or Hold NRP

There are two very strong indicators that NRP should not be bought at this point in time. Looking at it from a long-term prospective the firm's debts are an issue. And from the short-term view, the stock is performing terribly. However, it is not as clear cut as that. Since NRP's cash and cash equivalence position is very strong it appears NRP will not only maintain the high dividend, but it also allows NRP to possibly pay back some debt and lower the debt to assets ratio. Another way to lower this ratio back to historical levels is acquire more assets with cash, not debt.

The key in my mind is NRP's income statement. From first glance, it is a complete mess. When a company's net income declines by 65% in one year, investors should be concerned. However, since this decline was due to impairment charges, I feel confident saying that we need at least one more quarter before abandoning ship or jumping onto the bandwagon. If NRP can bounce back, investors will be rewarded with strong stock price returns, as well as the dividend. Keep in mind that as the share price moves higher the dividend percent will decline.

At this point it appears NRP is a hold. If you are not already invested, I would stay away because there are better options; such as AT&T (T) with a 5.6% dividend and more potential for growth. There are two reasons why I am not listing NRP as sell. The first is simply because you never want to sell at the bottom. Even though NRP broke through one strong floor, I do not expect the stock to dip down below $20.50-$21.00; assuming severe economic weakness is avoided. The second reason is because of NRP's dividend.

Buying NRP would be a risky play because the stock can definitely go lower in the near term. Even buying NRP as a long-term position is risky because of the massive debt load and struggling coal mines. Therefore, until coal begins to show signs of strength, NRP should be labeled as a hold. However, once coal begins to show any signs of strength, NRP should be a definite buy in order to take advantage of that large dividend and the coal industry.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.