Description

As a result of several cash-generative catalysts unfolding in real time, we recommend the purchase of NRP.  NRP is an MLP trading at only 1x 2022 expected cash flow when you back out its 49% stake in the Ciner Wyoming soda ash mine, a segment where the value was established in a private market transaction two months ago after a Goldman-led process.  Our 1x cash flow multiple is based on the following catalysts:

1. A strong recovery in the soda ash business, which has led to reinstatement of Ciner’s $28M annual dividend to NRP on October 29, this private market sale of part of Ciner in November, and a subsequent Ciner dividend increase on January 27 to $54M annually. 
2. 2022 domestic met coal price increases of $90-$100 per ton versus 2021, which is a ~100% increase off the lows seen during covid.
3. Export met coal pricing of more than $400 per ton as of the end of January, which is a historic high.
4. The completion of a carbon sequestration project that generated $14M of profit that will flow through Q4 financials as well as the announcement of a new sequestration project with Denbury that may be significant.
5. A positive thermal coal environment as > $3 natural gas pricing provides demand momentum for coal.

The impact of the above is cash generation of >$500M or $40/share in cash over the next two years which is more than the entire equity value of the company at current prices. 

With this cash generation and based on normalized 2023 EBITDA that assumes $175 met coal and a 6x target multiple, we estimate a fair value for NRP of $82.  This fair value reflects a 6x EBITDA multiple for the entire company, which is the Company’s historical average EV/EBITDA multiple in recent years but highly conservative given the recent soda ash price tag and these positive catalysts.  Valuing NRP’s Ciner stake at the value implied by the recent private market transaction and the rest of its business at 6x implies a price target of $115 for NRP. 

Business

NRP has two business segments: 1) coal and 2) soda ash. 

Coal Royalty: NRP owns the mineral rights to land where coal is mined.  They have long-term, percentage of revenue leases with their met coal producing customers.  The typical lease is 10 years, with a lease rate of around 5% of revenue, collected when the coal is sold to a third party.  Met coal is 50% of volumes mined and 65% of coal royalty revenue.  Met coal is a key input in steel production and demand typically grows with global GDP.  The vast majority of worldwide met coal is mined in China and Australia and the US is a small producer with most production consumed domestically, but US producers will export when prices are high enough as they certainly are now.  We think that NRP’s met coal producer customers produce roughly 11-12M tons for domestic consumption, with their remaining 0-3M tons sold in the export market.  Domestic production/consumption is contractual and priced on an annual basis while exported coal prices based on the spot market. 

Thermal coal is the remaining 50% of volumes mined and accounts for ~35% of coal royalty revenue.  Thermal coal is primarily used as an input in coal-fired electricity plants. This business is shrinking at a msd rate for the industry overall, as a result of the historically higher cost of coal relative to natural gas, coal-fired plant retirements and weather.  NRP’s thermal mines have recently outperformed with flattish volumes over the last three years and an increase in 2021 due to a temporary shift in volumes from one specific customer with a fixed revenue contract. We are modelling thermal volumes to revert to their pre-2021 levels, in 2022+. NRP’s market advantage is that half of its thermal coal comes from the ILB, which is the lowest cost-to-produce coal in the US.  Another 30% comes from the Powder River Basin, where the utility is essentially co-located on NRP’s land so there is no competition.  Contracts today are usually 1-3 years in length between utilities and thermal coal producers and there’s a committed volume range with prices that reset annually. 

Coal Other: The coal business also generates revenue from contract minimums, transportation and processing fees, property taxes passed on, wheelage fees, hard mineral royalty revenues, oil and gas royalty revenue, and a few other small line items.  Individually, none of these items are large but combined, the other revenue in the coal business equates to roughly $20M a quarter, which is significant. 

Soda Ash: NRP owns half of the Ciner Wyoming trona mine, from which soda ash is mined.  Soda ash is a naturally occurring chemical compound used to make glass, detergents, and a wide variety of common products.  This business typically grows at 3% annually.  Ciner Wyoming is one of four major players in the US market.  The US market is the lowest cost soda ash market in the world.  Most of the world’s soda ash is produced synthetically (vs. naturally in the US).  Synthetic soda ash production costs average around $170/ton, which is 2x the natural soda ash production costs of $85/ton, and synthetic production has substantial negative environmental impact.  As a result, Ciner Wyoming and all the US producers generally sell all that they can produce.   

Catalysts

Ciner’s strong recovery

Worldwide soda ash pricing is strong, at > 3x the lows of 2020 and reaching five-year highs in November.  Worldwide demand is outpacing supply.  A recent write-up on Ciner by htm815 provides good additional color on the soda ash market and the Sisecam transaction.  Sisecam also released a presentation of their view of the soda ash market with their purchase of the Ciner stake in November:

https://www.sisecam.com.tr/sites/catalogs/en/Investor%20Relations/Presentations%20and%20Bulletins/Investor%20Presentations/2021/US%20Natural%20Soda%20Investment-Webcast%20Prez.pdf

On May 10, 2019, Ciner reduced their quarterly distribution from $0.56 to $0.34 citing increasing growth capex needs.  They then eliminated the distribution completely starting in Q2 2020 due to concerns related to Covid.  CINR returned to a $0.34 distribution in Q3 2021 and then unexpectedly increased the distribution to $0.65 for Q4 2021.  We presume this is a function of particularly strong soda ash pricing and over four quarters results in $54M of cash flow to NRP.  Based on Ciner’s historical average cash flows, this $54M annualized rate may not be sustainable beyond 2022, so we assume they revert to the $0.34/share distribution level in 2023, or $28M of annual distributions to NRP.  This may well be conservative – Ciner was paying out about $46M of annual distributions to NRP for years pre-covid, pre-capex.

Applying a 6.0x multiple to $28M implies $13/share of value.  The incremental cash over the next nine quarters is $89M, or another $7/share.

Met coal prices at historic highs

Met coal pricing has skyrocketed.  The Australian hard coking coal benchmark hit a historic high at the end of January above $400/ton and continues to make records.  Global demand increases combined with supply chain shortages and a Chinese trading ban on Australian met coal have created the perfect storm for met coal supply and demand imbalance.  This pricing is not sustainable but will provide a temporary windfall of cash flow to NRP.  We estimate it will add at least $80M in incremental cash flow, or around $6/share.    

We believe that 12M of the 15M tons produced by NRP’s met coal leasee base supply the domestic steel market. Domestic met coal contract pricing is based off the global met coal benchmark with pricing set in the 3Q and 4Q for the year ahead. Several of the public producers disclosed in their 3Q results that 2022 domestic prices are $90-$100/ton higher than 2021 prices and our call work confirms pricing held into 4Q.  12M tons * $95 incremental per ton * 5% royalty revenue = $57M incremental cash from the domestic met coal business.  This is pure profit to NRP and equates to ~$4.50/share.

The remaining 3M met coal tons produced by NRP customers sell into the export market.  Most of these tons supply the European market, although this year some tons have made their way to China, which is unusual.  These tons are sold at spot prices, which are volatile, but prices are high right now.  Our call work suggests that the current environment is likely to continue until at least mid-2022.  Longer-term, a reasonable floor for global met coal pricing is $150/ton.  This is the price at which Chinese production historically comes offline because it is unprofitable to produce.  We are modeling $175/ton for the normalized numbers in our model, or 16% above this $150 floor.  Assuming three quarters of met coal spot pricing of ~$360/ton (conservative compared to actuals and forward curve pricing) through 2Q22 vs. ~$150/ton for the TTM, 2.25M tons sold over that 9-month period, and a 5% royalty rate, implies $24m of incremental cash flow from NRP customer export market sales.  Again, this is pure profit to NRP and works out to ~$1.80/share.  Visibility is limited beyond 2Q22, but supply chain shortages show no sign of abating as of right now. 

Met coal supply will increase (a little)

The 15M tons of met coal produced by NRP’s tenants reflects slightly higher volume than the recent past, despite the favorable pricing environment.  It is hard to bring met coal supply online. However, in good met coal pricing years, industry production and NRP volumes do increase.  The producers are doing anything they possibly can (extra shifts, delayed maintenance, etc.) to take advantage of the global pricing environment.  US mines in particular are global swing producers and therefore take this approach more so than producers in other countries. 

NRP’s producer customer base produced 11M tons on a TTM basis and at a 14M ton run rate in the 3Q.  Volumes last hit 15M met coal tons in 2018 when met coal pricing averaged $204 for the year, so this volume has precedent (and met coal is currently double the 2018 average). The addition of 4M tons versus TTM volumes adds another 4M * ~$150/ton TTM * 5% royalty rate = $30M of FCF. These 4M tons will likely be eliminated when global pricing reverts to more normal levels, but this adds another $2/share of value for the 4 quarters of 2022. 

Environmentally friendly projects showing potential

In the third quarter of 2021, NRP announced the sequestration of over 1 million tons of carbon dioxide in their forestlands. For this project, they will receive $14M in the 4Q, or about $1/share.  While this project is one-time, they continue to evaluate other environmental projects that take advantage of their millions of acres of land around the country.  For example, they are exploring projects to lease surface acreage for renewable energy projects such as solar arrays and wind farms.  In addition, they are assessing their forest timber assets for additional carbon sequestration. 

NRP announced a new carbon sequestration project with Denbury with carbon dioxide storage potential of over 300M tons (vs. 1M tons in their prior project). Denbury's latest investor presentation highlights Section 45Q of the IRS tax code, which reflects current carbon storage tax credits of $50/MT for storage and proposed tax credits of $85/MT. This could be a significant profit generator for NRP which they are not currently receiving credit for.

Thermal coal strength

Longer-term, NRP’s thermal coal revenue will be challenged due to secular pressure s utilities switch from coal as their source for electricity production, although volumes have been flattish for the last three years and currently, there is considerably more demand for thermal coal than otherwise due to high natural gas prices both in the US and internationally.  Natural gas is $4 and December prices in Europe hit record highs above $40, or >10x the price of the same amount in the US and 8x above the European price last year at the same time. 

The very rough rule of thumb is that when the price of natural gas is >$3, it makes more sense to use coal than natural gas for electricity generation.  Additionally, natural gas prices have also been so low for so long that coal inventory levels at many domestic utilities are at record lows leading to a restocking.  This is if utilities can even get thermal coal as international prices are so high, producers who can export, are exporting.  Thermal coal costs of production are $40-$45/ton and with international thermal coal pricing (API2) at $180/ton today, the export market is highly profitable.  Note that natural gas exports are also highly profitable at the moment, and the two markets are in somewhat of a feedback loop.

There are two bright spots associated with strong thermal coal pricing for NRP.  Illinois Basin coal pricing is ~$10/ton higher than last year.  NRP’s producers will produce 6M tons of ILB met coal in 2022 implying $3M of incremental upside assuming a 5% royalty rate. 

Another 3M tons of NRP’s thermal coal revenue comes from the Power River Basin where thermal coal pricing is ~$20/ton higher than last year. This implies $3M of incremental cash flow assuming a $20/ton increase, 3M tons of production and a 5% royalty rate.  Together, the Illinois Basin and the Powder River Basin represent $6M of incremental cash flow, or ~$0.50/share.        

Debt pay-down

NRP’s TTM EBITDA was $120M and we expect an incremental $190M through yearend 2022, consisting of:

• $61M from CINR distribution resumption (one quarter at $7M/quarter + four quarters at $13.5M/quarter)
• $80M from improved met coal pricing
• $30M from improved met coal volumes
• $14M from the already announced carbon sequestration project and potentially more associated with the Denbury announcement
• $6M from improved thermal coal pricing

$48M of the $190M is sustainable going forward assuming met coal normalized pricing of $175/ton and a $28M annual distribution from CINR.  Normalized EBITDA for NRP is $175M/year in 2023 vs. the >$300M we anticipate in 2022. 

NRP converts 80% of its EBITDA to cash flow.  Over the nine quarters between Q4 2021 through 2023, NRP will likely generate $500M in FCF and $40/share in cash.  Their ending cash balance at year-end 2023 should be more than enough cash to comfortably repay their $300M 9.125% notes.  These notes mature in June 2025.  They cost $27M per year in interest (or >$2/share in cash) and can be redeemed for a 2-3% penalty before 2023 or without penalty after October 30, 2023.  Repayment of these notes is NRP’s priority.  Doing so opens the path towards increasing shareholder distributions.

Assuming a debt redemption and normalized business environment, NRP will generate net cash of ~$114M in 2024 and net cash of ~$131M in 2025 after all preferred and mandatory principal obligations.  With 12.9M shares outstanding after warrants exercised, that’s a lot of cash available to increase distributions to shareholders.  At a 1.5x distribution coverage ratio, the dividends could be almost $6/share in 2024 and $7/share in 2025 (versus the $1.92/share distribution today).

Lastly, NRP has an expensive $250M convertible preferred note that bears interest at 12% held by Blackstone and GoldenTree. It has no maturity date and distributions can be Paid-In-Kind.  NRP’s take-out value is reduced by the preferred distributions paid.  The financing market in the coal sector is terrible, so the lack of a maturity date is an advantage, despite the 12% interest expense.  We believe this debt is less of a priority for NRP than paying off its other debt unless Blackstone/GoldenTree look to convert it to equity.  The conversion details are somewhat complex, but the notes are convertible at a stock price >$51 with a buy-out option by NRP at an ~8% premium.  We believe that this buy-out option is the likeliest course of action should Blackstone convert, which reduces Blackstone's conversion incentive.  However, should conversion occur, dilution is further capped by three factors:

• Only 1/3 of the convert can convert each year, which is at most (at $51/share) 1.8M shares
• The share count is adjusted based on the share price such that a higher stock price converts into less shares
• Daily liquidity in NRP today is around $1M/day making it difficult to imagine Blackstone and GoldenTree converting $90M of stock annually and reliably selling down their stake at a satisfactory price with only $1M of daily liquidity

Of course, this may change over time but there are some constraints around MLP investing, and particularly around coal MLPs, that may hold daily liquidity perpetually low and dramatically reduce the chances that Blackstone and GoldenTree ever convert into equity.  The convert is accounted for as debt in our analysis.

Valuation

Our forecast results in a $82 price target using 6.0x 2023 EBITDA which reflects a normalized met coal price of $175/ton.

EBITDA to FCF conversion has averaged 80% over the last three years, implying a 16% FCF yield assumption at our target price which is conservative. 

Several royalty comps (Altius, Anglo Pacific, Black Stone Materials) trade at 13-18x EV/EBITDA.  Coal comps (Alpha, Warrior, Ramaco and Arch) are trading at 6-15x, with an average of 7-9x.  Coal companies typically have much lower FCF conversion.  Our 6.0x multiple is in-line with the historical averages for NRP, although appears highly conservative based on comps, current market dynamics and the standalone Ciner stake valuation.

More interestingly, if we value the business using a sum-of-the-parts with the recent implied price for the soda ash stake, we get a price target of $115 for NRP of 2023 normalized EBITDA.

Risks

-          Met coal price volatility

-          Thermal coal demand declines

-          Low liquidity 

-          Blackstone dilution

Catalyst

-          Soda ash distributions

-          Market digestion of the recent soda ash transaction value

-          Favorable 2022 domestic met coal contract pricing

-          Export met coal pricing strength

-          Met coal production volume increases

-          Additional ESG projects

-          Capital structure changes including repayment of debt and distribution increases