We maintain our Neutral recommendation on Natural Resource Partners L.P. (NRP) as we expect the partnership to benefit from the improvement in coal market fundamentals, recent acquisitions, strong liquidity and solid quarterly results.
Through the first half of 2011, metallurgical coal production at Natural Resource Partners was strong, accounting for 37% of production and 47% of coal royalty revenues. Going forward, we expect the dynamics of coal demand to improve.
The demand for steam coal and metallurgical coal is steadily rising due to the economic recovery in the United States and other countries around the globe. The partnership only stands to gain from reinvigorated demand for this source of fossil fuel, in our view.
For businesses like Natural Resource Partners, the way to add value is by increasing reserves, since these represent future minable coal and thus future cash streams. In keeping with its growth-by-acquisition strategy, the partnership bought additional reserves in the Deer Run mine in the Illinois Basin in the second quarter.
We appreciate this strategic move, which should allow the partnership to increase production from this basin and meet the increasing demand for coal.
Notably, Natural Resource Partners has generated about 70%-80% of its operating cash flows from coal royalties. As of June 30, 2011, the partnership generated operating cash flows of $91.7 million compared with $71.7 million in the prior-year quarter.
Additionally, the elimination of incentive distribution rights highlights the partnership’s modified capital structure, with ample cash available for acquisitions and distribution increases.
Consequently, we believe Natural Resource is remarkably well positioned to grow distributions over the long-term. Presently, the partnership has a cash distribution of $0.54 per unit ($2.16 on an annualized basis), which represents a distribution yield of 7.9%, substantially above the industry average of 2.4%.
However, we believe the above-mentioned positives are already reflected in the valuation. Also, continued depletion of mineral reserves and the partnership’s dependence on the capital markets to finance a portion of capital growth projects are matters of concern. This keeps us on the sidelines.
Based in Houston, Texas, Natural Resource Partners principally engages in the business of owning and managing mineral reserve properties. The partnership mainly owns coal, aggregate and oil and gas reserves across the United States. The company competes with Peabody Energy Corporation (BTU) and CONSOL Energy Inc. (CNX). Natural Resource Partners currently retains a Zacks #3 Rank (short-term Hold rating).
