This week, we revisit a diversified natural resource company that continues to improve its balance sheet and recently posted superb performance for the first half of 2016. We have looked at Natural Resource Partners on two previous occasions, first in February and then again in April 2016. Since that time the company has posted results for its most recent quarter and the first half of 2016.
For the first six months of 2016, NRP has reduced its debt by $88.5 million.
Between April 2015 and June 2016, the company eliminated nearly $255 million in debt.
Net income for the six months ending June 30, 2016 increased an impressive 45% over the prior year period.
Interest coverage remains strong at 3.3x for the first half of 2016.
Thermal coal, whose use continues to decline in the U.S., now represents only 35% of NRP’s total revenues.
To support its goal of debt reduction, NRP has drastically reduced its quarterly dividend, directed excess cash flow to debt reduction and completed asset sales. Management is committed to improving the company’s financial metrics to position the company for long-term success. The dividend reduction clearly signals a current favoring of bondholders over stockholders, and management has the option for further dividend reductions to support NRP’s long-term goals. The bond price has risen substantially as risks continue to be diminished, yet these 25-month bonds are still yielding about 18.8% when priced around 84. Considering NRP’s sound 2016 financials, healthy interest coverage and its determined debt-reduction strategies, these short term notes from NRP make for a fine addition to both our FX1 and FX2 global high yield income portfolios.
What’s Changed – A Focus on Debt Reduction
In April 2015, NRP instituted a Strategic Plan in order to strengthen its balance sheet, reduce debt and enhance liquidity in order to position the company for future growth. Some of the goals of this plan included reducing the quarterly distribution to free up cash for debt payments, utilize excess cash to pay off approximately $500 million of debt by the end of 2017, and pursue NRP’s diversification strategy through organic growth of its aggregates, industrial minerals and oil and natural gas assets. In the 16 months since adopting this plan, NRP has made significant progress towards its goals.
First, the company appears to be on track to meet its goal of $500 million in debt reduction by the end of 2017. For 2015 and year-to-date 2016, NRP has had total debt reduction of nearly $255 million. For the first six months of this year, NRP reduced its debt by $88.5 million, including $37.3 million in Q2. As part of this plan, the company has determined to sell certain assets to meet it deleveraging objectives. Earlier this year, the company sold its oil and gas interests in the Williston Basin for $116.1 million. The majority of the proceeds from this sale went towards debt repayment. As indicated in the plan, the company also reduced its quarterly dividend. It has reduced its cash distributions by over 87% since 2015, using the excess cash for additional deleveraging.
Solid Q2 Results
NRP recently posted its quarterly results, including financials for the three months and six month periods ending June 30. 2016. The results are impressive, especially considering that the company still derives roughly half of its revenues from coal, which continues to experience decreasing prices. For the six-month period ending June 30, 2016, NRP increased its operating income from $104.8 million a year ago to $119.7 million, a 14% increase. Net income also increased in that time period, growing from $48.1 million in 2015 to $69.8 million in 2016, a handsome increase of 45%.
NRP’s interest coverage for the first six months of 2016 has remained strong. At our last review of NRP in April 2016 the company’s adjusted EBITDA / interest expense ratio was 3.11x. Taking that same measurement for the first six months of 2016 gives interest coverage of 3.3x (adjusted EBITDA of $145.48 million and interest expense of $44.25 million). Using the more traditional calculation of operating income / interest expense still yields healthy coverage of 2.7x ($119.73 operating income and $44.25 interest expense).
NRP and Land Leases
Natural Resource Partners does not operate any coal mines. It owns land that it leases to experienced operators under long-term leases (generally five to ten years). Lessees have the option to extend the lease. Leases may include the right to renegotiate rents and royalties for the extended term. Under the standard lease, lessees calculate royalty payments due to NRP and report tons of minerals removed as well as sales prices for extracted minerals. In addition to the royalty payments, lessees are often subject to pre-established minimum monthly, quarterly or annual payments. NRP is entitled to these minimum payments, even if no mining activity occurred during the period. These minimums are usually credited against future royalties earned as minerals are produced. Because NRP does not operate the coal mines, it does not bear ordinary operating costs. These costs are the responsibility of the operator.
About the Issuer
Natural Resource Partners LP is a master limited partnership headquartered in Houston, Texas. NRP is a diversified natural resource company that owns interests in oil and gas, coal, aggregates and industrial minerals across the United States. A large percentage of NRP’s revenues are generated from royalties and other passive income. NRP is not an active coal producer. Instead, they lease the land they own to operators who then mine and produce the coal to be sold at market. Thus, they do not bear the risk of bringing the coal to market. Last year, coal was responsible for generating nearly a third of the electricity in the U.S., so it is still a commodity in demand. In addition to the land and mineral rights, NRP owns a 49% equity investment in Ciner Wyoming LLC, a trona / soda ash operation, owns working interests in oil and gas properties and as of October 2014, owns VantaCore, a construction aggregate business, making NRP one of the top 25 aggregates producers in the United States. For the six months ending June 30, 2016, the company revenues sources were as follows: 53.9% coal and hard mineral royalty, 26.4% VantaCore, 0.7% oil and gas royalty, 9.3% Ciner Wyoming and 9.7% from gain on asset sales.
Outlook – Thermal Coal vs. Coking Coal
When most people think of coal, images of coal burning, electricity-generating plants come to mind. But that is not coal’s only use. Metallurgical coal (also known as coking coal) is also a key ingredient in the making and manufacturing of steel. As a percentage of total coal royalty revenues, metallurgical coal generated 34% of NRP’s coal royalty revenues for the six months ending June 30, 2016. Which means, as a weighted average, thermal coal (the type used to generate electricity) royalties were responsible for 35.5% of total revenues.
In recent weeks the price of both thermal and metallurgical coal has experienced a resurgence. These price increases are largely the result of China cutting back on its production of coal. At the beginning of 2016, the price for thermal coal coming out of New South Wales (Australia) was in the high $40 / ton range and have now moved up close to $70 / ton. Metallurgical coal has also risen from around $70 / ton to above $100 / ton.
Coal is a key material needed for developing and emerging economies around the world. One developing market is the country of India, whose coking coal imports by Indian steel makers are estimated at 50 tons for 2016, a 14% increase over the amount imported in 2015. According to analysts, limited domestic availability of coking coal will fuel more imports for India.
In recent years, the largest demand for steel (and for the coking coal needed to make it) has come from China. But recent slowdowns in the Chinese economy have meant that it has reduced its steel production. This could translate into some relief for domestic steel manufacturers, who have been plagued in recent years by imports of cheap steel. Indeed, U.S. steel imports this year are trending 30% lower year-over-year.
The risk is NRP’s ability to perform. The company has made excellent progress on reducing its debt. Management has also committed to additional asset sales in order to meet the company’s deleveraging goals. Q2 and 1H 2016 results look encouraging, with healthy year-over-year operating income and net income increases, as well as continued solid interest coverage. The drastic dividend reduction signals management is prioritizing NRP bondholders. Given these factors, we believe the excellent 17.8% yields on these very short-term bonds outweigh the risks identified.
NRP remains focused on improving its balance sheet through additional debt reductions. Part of this plan includes the possible sale of its assets. Recent trends in the coal sector (which still represents roughly half of NRP’s revenues) could affect the company’s prospects to sell its coal-related properties.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Over the past few years, Natural Resource Partners has redefined itself from a primarily coal-based company, to one that now receives nearly half of its revenues from other diversified sources. In spite of the continued challenges in the coal sector, NRP has continued to thrive, increasing many of its financial performance metrics in the first half of 2016. It continues to make steady progress on its goal of debt reduction, having paid off $255 million in debt over the last 16 months. Although coal usage for electricity is decreasing, coking coal is and will still be needed as a key ingredient for steel manufacturing. Therefore, these very short, 25-month bonds are an excellent opportunity for investors to increase cash flow and overall portfolio yields, so we have marked them for additional weighting in both our Fixed-Income1.com and Fixed-Income2.com global high yield income portfolios.
Issuer: Natural Resource Partners LP
Ratings: Caa2 / CCC-
Yield to Maturity: ~18.81%
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Disclosure: Durig Capital and certain clients may have positions in Natural Resource Partner’s 2018 bonds.
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