|Shares Out. (in M):||12||P/E||3.0||2.9|
|Market Cap (in $M):||362||P/FCF||3.0||2.9|
|Net Debt (in $M):||798||EBIT||220||220|
We believe Natural Resource Partners (NRP) units are a compelling value investment in an out-of-favor industry masked by a complicated capital structure, with key investment risks mitigated by significant free cash flow generation in a business model that is stable over time, natural capital structure simplification, and strong alignment with a controlling shareholder that is highly incentivized to increase the price of NRP units.
NRP has 3 business segments. NRP’s coal royalty business owns and leases reserves to coal mining companies in CAPP, NAPP, ILB and PRB. This segment accounts for 72.5% of 2017 segment EBITDA. NRP’s second largest business is its 49% ownership interest in Ciner Wyoming, a soda ash mine and refinery, with distributions from Ciner Wyoming accounting for 19.6% of 2017 segment EBITDA. Finally, NRP owns a construction aggregates business with locations in several Eastern and Southern states, accounting for 7.9% of 2017 segment EBITDA.
NRP went public in October 2002 and is controlled by the Robertson family, who serves as the GP and also owns a 33.7% interest in NRP common units. NRP is structured as a master limited partnership with no incentive distribution rights. The company survived the 2015 - 2016 commodity cycle, but not without some scars. As a result of some poorly timed, ill-advised leveraged acquisitions, the company was forced to cut its dividend over 90%, conduct a distressed exchange offer, sell all of its non-operated oil and gas working interests, and take a high cost convertible preferred from Blackstone and GoldenTree in order to stave off bankruptcy. In the midst of all this turmoil, NRP units underwent a 10-for-1 reverse split. This has led to the complicated current day capital structure below:
The Blackstone/GoldenTree 12% convertible preferred at first glance appears to pose a significant dilutive threat to NRP unitholders. However, due to its highly structured terms, there are many built in protections to preserve the Robertson family’s common unit stake in the company. The preferred is not convertible until February 2022 at the earliest and is not convertible at that time unless NRP’s unit price is in excess of $51.00 per share. Even if both of those conditions are met, a maximum of 1/3 of the preferred can convert each year, and NRP has the right to redeem the converting preferred in cash. Based on this structure, we believe NRP is highly motivated to get its share price as high as possible, to minimize dilution upon the preferred converting (assuming NRP chooses not to redeem the preferred). Note that we present the preferred at 1.5x face in our capital structure table above since the preferred is redeemable by NRP at any time through February 2020 at 1.5x face.
While the company has made mistakes in the past, we believe NRP is poised to create substantial value for unitholders going forward. NRP is highly free cash flow generative. In the near term, NRP is required to pay down debt to achieve target leverage levels of 3.0x and we believe the company will achieve this leverage target by 1H 2019. Thereafter, we expect the company will begin to raise the distribution on its common units in an effort to drive a unit price re-rating higher and limit dilution from the convertible preferred. On NRP’s 3rd quarter 2017 earnings call, President and COO Craig Nunez stated, “Our primary focus is going to be enhancing unitholder value, and we will consider everything we can do to do that and clearly distribution increase is going to be high on that list.” Assuming flat EBITDA over the next 4 years, and a payout ratio increasing to 70%, we believe NRP can raise its dividend from $1.80 annually today to $7.50 per share by 2021, as illustrated below. At a constant dividend yield, this would imply a price per unit of $123.
Alternatively, we value NRP units on a sum of the parts basis.
We value the coal royalty segment at 10x EBITDA based on the average trading multiple of several non-precious metal royalty comparables.
We believe the biggest risk to our thesis lies within the earnings profile of the coal royalty business. Volumes and earnings generation from this segment has been volatile in the past, but we believe that the coal production remaining on NRP reserves today has been battle tested. The remaining coal production has withstood several quarters of sub-$100 seaborne met pricing and low $30s ILB pricing in 2015 and 2016. In addition, most of NRP’s lessees have improved their balance sheets and cost structures through in and out of court restructurings over the last few years.
An additional source of upside that we do not incorporate in our valuation, is any recovery NRP might secure from its litigation against Foresight for nonpayment on Deer Run and Macoupin leases. We estimate this could be worth $100 million to NRP, or ~$8 per unit.