Natural Resource Partners Is Poised To Perform Well In The New Era

May 20, 2022 11:56 AM ETNatural Resource Partners L.P. (NRP)8 Comments2 Likes
Gavin Barwell profile picture
Gavin Barwell
189 Followers

Summary

  • The metals and mining sector has had a horrible decade and with it, Natural Resource Partners.
  • Present conditions suggests that demand for minerals is set to increase and with that, the company is poised to grow and fatten profitability.
  • In an era of de-globalization, the company’s assets will become more valuable.
  • Natural Resource Partners’ free cash flows are trading at a yield of 25.49% and the stock is cheap by historical and relative measures.

Business on Wall Street in Manhattan

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Natural Resource Partners L.P. (NYSE:NRP) has a unique model that de-risks by shifting the downside of metals and mining to its leasees. The company's performance is largely a function of the market, although de-risking exists. In the current economic and geopolitical environment, the industry and therefore the company, are likely to sharply appreciate. This presents a buying opportunity for investors, given that the partnership is severely undervalued.

A Decade to Forget

Since its 2002 listing, Natural Resource Partners' stock market performance has reflected the ebbs and flows of the commodities industry. In that nearly two-decade period, the stock has risen with the commodities boom, and crashed with the commodities bust, earning investors a total return of 1.74% and a compound annual growth rate (CAGR) on their investment of just 0.09%.

Source: Natural Resource Partners LP

Source: Natural Resource Partners LP

That boom and bust period somewhat mirrors the performance of the MSCI ACWI World Metals and Mining Index. The real difference between the two is that whereas the MSCI ACWI World Metals and Mining Index recovered from its 2016 bottom, six years later, Natural Resource Partners.

MSCI ACWI World Metals and Mining Index

MSCI ACWI World Metals and Mining Index

Since 2000, the MSCI ACWI World Metals and Mining Index has performed at 8.85% per year with a Sharpe ratio of 0.39, compared to 5.92% for the MSCI World Index with a Sharpe ratio of 0.35. However, the last decade has been a traumatic one for metals and mining and an even more traumatic one for Natural Resource Partners. In this last decade, the MSCI ACWI World Metals and Mining Index has grown at 2.97% per year, with a Sharpe ratio of 0.21, compared to 10.05% for the MSCI World Index with a Sharpe ratio of 0.35. In tandem, Natural Resource Partners has produced the kind of performance that would horrify most investors, producing a total return of -80.02% and a CAGR of -14.89%.

Source: Natural Resource Partners

Source: Natural Resource Partners

The company's financial performance reflects the economics of the industry and its own unique business model. Revenue declined from $379.15 million in 2012, to over $216 million in 2021. Gross profits declined from over $358 million in 2012 to more than $189 million in 2021. Net income also declined, from nearly $210 million to nearly $76 million. Gross margin declined from an exceptional 94.33% in 2012 to a still-exceptional 87.5% in 2021. However, the company's free cash flow (FCF) margin grew from 23.79% in 2012, to 56.3% in 2021. FCF grew from $90 million in 2012 to $123 million in 2012. The company's assets declined from nearly $1.8 billion in 2012, to $953 million in 2021. The partnership's return on invested capital (ROIC) tells us the story of their unique business model, which earns the company double-digit ROIC in good times, and of just how bad business can get in downturns.

Source: Company Filings

Source: Company Filings

The question for investors is, "Are we headed into good times?" An analysis of the company's business model will show the headwinds that could lead to the kind of upward revision in valuation suggested by the rising ROIC.

Natural Resource Partners' Business Model

According to its 2021 Annual Report, Natural Resource Partners operates, manages and leases a portfolio of mineral properties in the United States, including interests in coal. The partnership also owns a 49% interest in trona ore miner and soda ash producer, Sisecam Wyoming LLC.

The company operates through two segments, Mineral Rights (covering 13 million acres of mineral interests and other subsurface rights across the country) and Soda Ash (by way of Sisecam Wyoming). Mineral rights make up the vast majority of the company's revenue.

Source: 2021 Annual Report

Source: 2021 Annual Report

The map below shows the company's ownership footprint.

Source: 2021 Annual Report

Source: 2021 Annual Report

Mineral Rights

The Mineral Rights segment used to be called the Coal Royalty and Other business segment, reflecting the importance of coal revenue in the segment. As the company's mineral rights have diversified and the company has transitioned to renewables, the name has been changed.

Similar to Texas Pacific Land Corporation (TPL), the company does not mine, drill or produce any minerals. Instead, the company leases its land to miners, who pay it a royalty (typically based on gross revenues of leasees) and other fees. The leasees agree to pay a floor price and minimum payment obligation to de-risk the partnership from the well-known cyclicality of the industry. Metallurgical coal contributed 65% of royalties in 2021 and 50% of volumes mined. Thermal coal is responsible for 50% of volumes and 35% of royalties. The segment earned $161 million in FCF in 2021.

Source: 2021 Annual Report

Source: 2021 Annual Report

Typically, leases are for a decade, with a range of five to 40 years, with a lease rate set at ~5% of gross revenue, collected upon collection by the buyer. Coal is key to the production of steel. As the GDP grows, so too does demand for coal.

On Geopolitics and Energy Inertia

The top 3 major coal producing countries in the world are China, India and Indonesia. Although the United States is fourth on that list, ahead of Australia and Russia, the United States production has plunged over the last few decades, as a consequence of cheaper alternatives abroad, and domestic environmental legislation and pressure from ESG investors.

Source: Wikipedia

Source: Wikipedia

Importantly for the company, Russia's invasion of Ukraine has sent the world into a period of de-globalization and re-shoring, and heightened risk for countries dependent on supply from potentially adversarial nations. Geopolitical considerations will drive countries to reconsider their dependence on foreign supply, and consequently, make Natural Resource Partners mineral rights more valuable. Most of the United States' production is consumed domestically (Natural Resource Partners' coal producers produce about 11 to 12 million tonnes for domestic consumption and just 0 to 3 million tonnes for international consumption), but with Russia effectively off limits, available supply for the European Union and the United States has dramatically reduced and the value of what we can call, "allied" supply has gone up.

Country

2020

2019

2018

2017

2016

2015

2014

2013

2007

China

3,902.0

3,846.3

3,697.7

3,523.2

3,411.0

3,747.0

3,874.0

3,974.3

2,536.7

India

756.5

753.9

760.4

716.0

692.4

677.5

648.1

608.5

478.2

Indonesia

562.5

616.1

557.8

461.0

434.0

392.0

458.0

474.6

174.8

United States

484.7

640.8

686.0

702.3

660.6

812.8

906.9

893.4

1,039.2

Australia

476.7

504.1

502.0

481.3

492.8

484.5

503.2

472.8

393.9

Russia

399.8

440.9

441.6

411.2

385.4

373.3

357.6

355.2

314.2

South Africa

248.3

258.4

250.0

252.3

251.2

252.1

260.5

256.3

269.4

Kazakhstan

113.2

115.0

118.5

111.1

102.4

106.5

108.7

119.6

94.4

Germany

107.4

131.3

168.8

175.1

176.1

183.3

185.8

190.6

201.9

Poland

100.7

112.4

122.4

127.1

131.1

135.5

137.1

142.9

145.8

Source: Wikipedia

Investors, the media, governments and even companies are guilty of exaggerating the possibilities of a rapid transition to renewables. The data paints a very different picture. Although Natural Resource Partners is making the transition to renewables, the global economy and indeed that of the United States, is still predominantly fossil fuel based, and, according to Czech-Canadian scientist and policy analyst Vaclav Smil, a rapid transition to renewables is not possible in the near-to-medium term. Estimates from the International Energy Agency show that rather than rapid transition, the world is stuck in what Smil refers to as "energy inertia", with coal, oil and natural gas making up 80.9% of the world's primary energy in 2019, compared to 87% in 1971.

Thus, post-pandemic inflation and growth will lead to a rise in demand for coal and a greater willingness from within the United States and partners in the European Union, to exploit American coal.

Natural resource Partners' domestic-oriented coal is typically cold on a contract basis, whereas that produced for international consumption is produced on a spot basis. With inflation growing, coal for international consumption will have a rising share of revenue in 2021.

The segment also earns revenue from other activities, which, on their own, are not meaningful, but add up to about $80 million a year. For instance, as part of the company's transition to renewables, last year, it signed an agreement to sequester approximately 1 million metric tonnes of carbon dioxide in parts of its forestland. The deal is worth $14 million and adds a new, meaningful source of revenue.

Soda Ash

This business is conducted through Sisecam Wyoming, which owns the soda ash producing Ciner Wyoming trona mine. The soda ash business grows at about 3% a year and Sisecam is one of the four largest producers of soda ash in the country. In 2021, the segment earned $11 million in FCF.

Compared to the rest of the world, the United States produces its soda ash naturally, whereas much of the world produces it synthetically. This leads to a meaningful price differential, with natural soda ash typically half as cheap as synthetic soda ash, and with fewer negative environmental effects. Consequently, soda producers in the United States are able to produce and sell at will, knowing they are the lowest cost producers in the world.

Globally, the soda ash market is booming, with the market value of global soda ash expected to grow again in 2022 and the years ahead.

Source: Statista

Source: Statista

Indeed, since 2020, prices have more than doubled.

Source: Trading Economics

Source: Trading Economics

Valuation

Natural Resource Partner has a very attractive FCF yield of 25.49%. This indicates that the company is currently producing more FCF than it needs to support its business, and that this growing sum of FCF is sharply discounted by the market. FCF yield is a more powerful signal than the PE multiple.

At 6.03, the partnership is trading at a discount to the 48.19 PE multiple of the metals and mining sector, according to Prof. Aswath Damodaran's data, and its 5-year PE average of 8.63. The S&P 500 has a PE multiple of 19.72.

So, the partnership is trading at a discount to its historical numbers, the industry average, and the market, and its FCF is trading at a very attractive level.

Conclusion

Natural Resource Partners has had a torrid decade. However, the world is shifting toward a period of inflation, and rising demand for minerals, a situation exacerbated by the present de-globalization period. The success of the company is intimately linked to that of the mining and metals sector is going to be a winner during this period. Geopolitical uncertainty will make this partnership's US-centered assets more valuable, given the loss of Russia as a supply source for coal for the European Union. The company is trading at a low relative valuation and its FCF has been sharply discounted by the market.

This article was written by

Gavin Barwell profile picture
189 Followers
I'm a UK-based entrepreneur and manage a portfolio of mostly UK stocks. I maintain a broad overview of US markets and analyse stocks for my edification only. None of my investment advice should be acted upon.
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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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