Natural Resource Partners: Lifeline From Eastern Europe, Upside Remains Limited

Daniel Thurecht profile picture
Daniel Thurecht
9.48K Followers

Summary

  • Natural Resource Partners saw their distributions saved by the strong coal prices of late 2021.
  • This also sent their cash flow performance surging higher, which if continued would see their best annual results in recent history since at least 2018.
  • When looking ahead, their thermal coal production is heavily weighted towards the Illinois Basis and thus stands to benefit via exports to Europe following their ban on Russian imports.
  • This would normally see prospects for distribution growth but sadly, an obscure term within their credit facility creates a problem since it would reduce their covenant leverage ratio limit.
  • Since this limits their ability to reward unitholders, I only believe that upgrading to a hold rating from my previous sell rating is appropriate.

Coal heap and one dollar banknotes on white background isolated close up, black coal rock, money bundle, mineral fossil fuel price concept, anthracite coal mining industry, power and energy banner

Vera Shestak/iStock via Getty Images

Introduction

If rewinding the calendar to the start of 2021, the distributions of thermal coal-reliant Natural Resource Partners (NYSE:NRP) appeared to be living on borrowed time, as my earlier article warned. To my surprise, coal prices rallied strongly as the global economy roared back to life after the severe Covid-19 downturn of 2020, thereby providing good fortunes that saved their distributions, as my previous article discussed. Despite helping, they still saw risks from the clean energy transition but fast forward to the present day and they now see a lifeline from Eastern Europe sanctions banning Russian coal imports following their widely publicized war atrocities in Ukraine, although the upside remains limited for their moderate 4% distribution yield due to another obscure problem.

Executive Summary & Ratings

Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.

Natural Resource Partners Ratings

Author

*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and also best captures the true impact upon their financial position.

Detailed Analysis

Natural Resource Partners Cash Flows

Author

The strong coal prices finally flowed through during the fourth quarter of 2021 and as a result, sent their cash flow performance surging higher. This saw their operating cash flow end 2021 with a result of $121.8m and thus almost twice their results of $66.6m seen during the preceding nine months. If annualized, their operating cash flow during the fourth quarter of 2021 was a very impressive $220.8m, which if continued, would be their best result in recent history since at least 2018. More importantly, this strong financial performance saw their leverage ratio decrease well below the level required to restart their preferred distributions and thus save their common distributions, as per the commentary from management included below.

"However, as our Mineral Rights and Soda Ash segment's business performance improved in the fourth quarter of 2021, our leverage ratio dropped well below this 3.75x threshold and ended the year at 2.7x. As a result, in February of this year, we fully redeemed all outstanding paid-in-kind preferred units at par and announced and paid cash distributions that included $0.45 per common unit and $7.5 million to our preferred unitholders."

-Natural Resource Partners Q4 2021 Conference Call.

After a scary ride during 2021, this now sees the risk of a distribution suspension formally resolved, as was expected when conducting my previous analysis in late 2021. Based upon my calculations, their outstanding paid-in-kind units would cost $24.9m to redeem and whist this would hinder their upcoming free cash flow during the first quarter of 2022, their cash flow performance can absorb this one-off impact. This aspect was discussed in greater detail within my two previously linked articles for any new readers who are interested. When looking ahead, the recent sanctions against Russian coal exports to Europe provide a lifeline for the producers in the United States and by extension for the thermal coal production that comprises a sizeable portion of their mineral rights, as the table included below displays.

Natural Resource Partners Production

Natural Resource Partners 2021 10-K

It can be seen that during 2021, slightly more than half of the production from their mineral rights was related to thermal coal with the Illinois Basin comprising almost two-thirds. Whilst the recent geopolitical events have lifted prices of thermal coal in virtually every basin, the Illinois Basin has seen one of the strongest rallies, as the graph included below displays.

Thermal Coal Prices

Nasdaq Data Link

Following the events in Eastern Europe, the price of thermal coal from the Illinois Basin rocketed to heights not seen in well over a decade, which has been driven by its ease of export and thus should promptly see more cargos heading to Europe in the future. When looking ahead, this is essentially tantamount to a lifeline that offsets a degree of risks surrounding the clean energy transition that was darkening their outlook. Although the exact extent remains impossible to quantify, not only due to the inherent volatility of commodity prices but the associated highly uncertain geopolitical backdrop driving this sudden change of fortune. It will also be equally as important to see how management utilizes this windfall because this event only delays the impacts of the clean energy transition and thus as a result, they still need to build their earnings elsewhere to offset its loss in the long-term.

Natural Resource Partners Capital Structure

Author

After seeing their cash flow performance surge higher during the fourth quarter of 2021, it was no surprise to see their net debt continue dropping in tandem to end the year at $298m and thus down noticeably versus its $334.5m when conducting the previous analysis following the third quarter. This now marks the first time their net debt has sunk below $300m in recent history since at least the end of 2018 and when looking ahead, it could even end 2022 below $200m if these very strong coal prices persist.

Natural Resource Partners Leverage Ratios

Author

Quite unsurprisingly, their strong financial performance and lower net debt have translated into lower leverage with their net debt-to-EBITDA and net debt-to-operating cash flow both ending 2021 at 1.74 and 2.45 respectively, thereby split between the low and moderate territories. Despite only seeing one quarter elapse, this nevertheless still marks a large improvement versus their results of 2.47 and 3.51 respectively when conducting the previous analysis following the third quarter of 2021. Whilst this would normally give rise to prospects of imminent distribution growth, especially given their very strong coverage and outlook for lower net debt during 2022, sadly, once again there remains another obscure problem hiding within their liquidity that throws the proverbial spanner in the works.

Natural Resource Partners Liquidity Ratios

Author

On the surface, their strong liquidity appears to offer ample support for higher distributions with their current ratio of 2.53 and accompanying relatively very large cash balance that gives rise to a cash ratio of 2.10. Whilst the risks to their distributions from their leverage ratio are resolved, it still creates a new problem that limits their ability to provide growth, as per the quote included below.

"The maximum leverage covenant under Opco's revolving credit facility will step down permanently from 4.0x to 3.0x if we increase the common unit distribution above the current level of $0.45 per common unit per quarter."

-Natural Resource Partners 2021 10-K (previously linked).

It can be seen that if they were to grow their distributions past their current quarterly rate of $0.45 per unit, the covenant for their credit facility would permanently reduce their leverage ratio limit from 4.00 down to only 3.00. Admittedly, their current leverage ratio of 2.70 remains below this limit but taking this path would leave virtually no margin of safety and thus require strong coal prices to persist well into the future, which is a very risky assumption. Whilst they currently have no balance drawn upon their credit facility, closing down and thus losing access to the facility would hinder the medium to long-term resilience of their liquidity if they were to face any future downturns. This would result in them retaining a higher cash balance than otherwise to compensate, which in turn, would still limit their ability to fund distribution growth.

Since their leverage ratio is defined by their total debt and not their net debt, any excess cash they generate in the short-term does not necessarily help resolve this problem as they are forced to wait for their scheduled debt maturities, as the table included below displays. Ironically, normally a nice and steady debt maturity profile is desired and supports distribution growth but in this rather unique situation, it actually limits their ability.

Natural Resource Partners Debt Maturities

Natural Resource Partners 2021 10-K

Conclusion

Even though the war atrocities in Eastern Europe are devastating, the resulting sanctions against Russian thermal coal exports provide a lifeline to United States thermal coal and as a result, stand to boost their short to medium-term financial performance, notwithstanding the inherent volatility of commodity prices. Despite this more favorable backdrop that offsets a degree of risks surrounding the clean energy transition, the obscure nature of their credit facility covenants once again creates a problem that limits their ability to reward unitholders with distribution growth and as a result, I only believe that upgrading to a hold rating from my previous sell rating is appropriate.

Notes: Unless specified otherwise, all figures in this article were taken from Natural Resource Partners' SEC filings, all calculated figures were performed by the author.

This article was written by

Daniel Thurecht profile picture
9.48K Followers
My analysis primarily focuses on income investments with a preference for those sporting high and very high yields.  Whilst this space often contains value traps, it also contains very desirable deep value opportunities that have the potential to generate significant alpha for investors, which I aim to highlight through careful fundamental analysis.  Apart from my extensive personal investment experience that spans over a decade, I have also obtained a Bachelor degree majoring in Finance, minoring in Accounting with Honours IIA.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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