Description

NRP has been written up twice in the last two years; both as longs from the equity side. Currently it looks like the bonds provide an interesting long term opportunity. 

Typically I look to find credit investments in value plays as over the long run the “pull to par” can get me out of a value trap; or in the case of a default would lead to creating the company at a significantly lower basis. 

I believe this is a case of the former versus the latter. The bonds are trading around 89.5 YTW of 11.6%; an 11.6% implied CAGR over the next 5 years doesn’t feel too bad to me.

Equity bulls have pointed to what would be a growing and well north of  1.0x coverage on its dividend as a reason to be long the equity. Management had pointed to hitting a target leverage that once reached shareholders believed the company would refocus on increasing its dividend and/or buying back stock. I think it was a solid idea however the MLP world has been absolutely decimated and more recently coal has (once again) taking a digger. Further I am not really sure if they were to have increased the dividend if investors would have shown up to buy yield  as MLPs have not exactly rallied with dividend increases (please see for example: nearly any MLP).

However, with coal sucking wind and their customers once again struggling, the decision to not have raised the dividend shows both discipline on the side of management and I believe a more permanent level of awareness that gives comfort that they have found balance sheet religion. 

I am not going to focus on a deep historical write up about NRP as that has been covered before but I think the chart from their August presentation is helpful to see the leverage over time (Note: This chart only goes through 6/30/19, Net leverage today is 2.2x; Gross is 2.6x).

 What I do think is worth talking about is “what is different” since the last write up. Historically the company had three main drivers of value: Soda Ash, Coal Royalties and aggregates (Vantacore). The aggregates business was sold for an 11x multiple, which combined with true debt pay down (as opposed to EBITDA growth which to be fair they have also gotten) has led to a strong de-levering of the company. 

Further the company both reduced, extended and lowered the coupon on its holdco debt and has continued to repay opco notes. In my mind the importance of the reduction of debt led by selling assets (which you can see repeatedly since 2016) is the sign of a management team that has seen one downturn to many. They aren’t trying to de-lever through growth (a far riskier way to clean a  balance sheet) they are taking down the ABSOLUTE dollars of leverage. 

The Soda ash business is a solid, low cost producer with decades of production ahead of it; the market is prepared for a lower DCF as a distribution cut has already been made and discussed in the company’s 10-Q as they now anticipate ~$25mm a year of distributions for the next 3 years prior to an increase again post reinvestment in the business.

What I really like about this set up is assuming any sort of valuation for soda-ash near current market values, combined with the cash on balance sheet takes out 100%+ of the opco notes and partially pays down the holdco notes, so barring any sort of incremental indebtedness caused by a difficult to see massive cash burn (not easy in a royalty business)  in a distressed scenario there is no question the holdco notes will be at worst the fulcrum creditor and I would argue are more than sufficiently covered (which the preferred holders would realistically argue).

Everyone hates coal I know; I don’t like it either. Thankfully this isn’t just coal. Using the company’s implied soda ash valuation we aren’t paying much for coal…and who would want to with comments like these?

“Four of our lessees …. have declared bankruptcy this year. In Foresight our largest lessee representing roughly 25% of our coal segment revenues has recently entered into a forbearance agreement with its lenders…Falling coal prices have not yet had a significant direct impact on our results, but we believe that's about to change as contracts entered into last year by our lessees expire and are replaced with new contracts and what we believe will be lower prices.”

What is great about the royalty business is NRP isn’t a creditor in the true sense; they own the mineral rights, they can sit on them and “wait” for a cycle to turn and as long as the mine itself is profitable enough for whoever the new equity owners will be of the chapter 22s that are going to rip through the coal space chances are they will renegotiate to pay something to NRP. Most creditors don’t simply want to shut it down and pack it in as their recoveries will be abysmal but instead will do the usual: cut costs, cut production (which will hurt NRP for sure), recapitalize and try and re-create a lower break-even cost than before and hope to get a reasonable market multiple on their post-petition equity.

If we use the middle of the range and assume the royalty stream can be sold off for 3.00x DCF ( a combination of both Met and Thermal); we need to make $33mm of DCF to justify the remaining ownership. In the first nine months of 2019 (and in 2018), 65% of the company’s Coal Royalty revenue came from metallurgical coal. If Thermal were to disappear, and metallurgical coal  were to take a significant price drop (the latter more logical than the former) one would still be covered handily on these bonds.

Management is cautious and doesn’t want to wait to see where coal bottoms this go around; the conference call starts out by talking about debt and their continued focus on it going forward:

“We also expect to continue our multi-year trend of reducing debt, albeit at a slower pace than we've delivered in recent years.”  To be clear; they are not talking about reducing Debt/EBITDA; just absolute debt which from a creditors perspective is wonderful.

Management is crystal clear they just want to keep paying down debt. Again: from the company presentation.

This seems like a solid opportunity to get a double digit return for a value name where management is focused on improving your position solely within the capital stack. 

Catalyst

A combination of continued Opco debt paydown, FELP and Contura going through chapter 22 and seeing how much production will be eliminated.