High Yielding Coal MLP's: These 2 Have Substantial Yield AND Upside
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I track four coal-heavy MLP's with distribution yields ranging from about 7% to 22%. The four names under consideration are Alliance Resource Partners (NASDAQ: ARLP), Natural Resource Partners (NYSE: NRP), Rhino Resource Partners (NYSE: RNO) and Oxford Resource Partners (NYSE: OXF). There's also Penn Virgina, but its much more diversified, coal-related sources of revenue are not a majority.
Coal markets have had a very rough trailing 12 months. Depending on the region, coal prices are down 20%-40%. Non-MLP coal stocks are down an average of about 65% from last year's highs. Not surprisingly, the units of MLP's have held up better, except for the units of Oxford which are down 60%.
Management teams in the sector have many essential decisions to make year after year: which coal basin, mix of coking coal and thermal coal, quality of coking coal, exports vs. domestic sales, acquisition strategy and balance sheet management. Navigating this decision tree has been difficult to say the least, especially as regulatory guidelines seem to be in constant flux.
From 30,000 feet, and with 20/20 hindsight, a coal-focused company would want to be in one or both of the best coal basins, namely the Illinois Basin (ILB) and Northern Appalachia (NAPP). Production of low cost coking coal but, importantly, high quality coking would be ideal. A focus on exports is very important. And companies that made large acquisitions at the top of the market are paying the price this year.
With these factors in mind, Alliance made a succession of excellent calls that enabled the company to post solid results through the 2008-09 financial crisis and thrive since then. The company is mostly in the ILB but is expanding into NAPP, check that box. Alliance has low-cost operations and a very healthy balance sheet with the lowest debt leverage among peers. And, Alliance is moving towards increased exports of its high-BTU thermal coal.
The operating results have been tremendous, allowing the company to increase annual distributions at a 15% CAGR over the past nine years! Growth in the distribution shows no obvious sign of slowing. Currently yielding about 6.7%, I believe a 1-yr total return of 30% is reasonable for ARLP. If the required distribution yield were to fall to 6.0%, the total return would be 34%. Last year the yield was as low as 4.25%.
NRP is yielding a hefty 11%, a possible red flag to some prospective investors who have been burned by falling distributions. However, this 11% yield is safe for at least the next two years. Of course, this is my opinion only; the Board will make that determination quarterly. NRP has publicly stated that it intends to maintain a cash balance equal to roughly two quarters' worth of distributions. Cash on 6/30/12 was $122 million. In the first two quarters of the year, there's been a shortfall in distributable cash flow of $15 million. If that rate of shortfall were to continue, NRP's cash balance would fall to $122 million minus $45 million = $77 million.
Before moving on, it should be noted that NRP is NOT a coal producer; it leases mineral resources and coal to companies that mine, extract and produce. This shields NRP from operating problems and headwinds like cost inflation and labor issues. In addition to a cash cushion, NRP is growing nicely in the ILB even as peers across the country retrench. Given its unique structure as a non-producing coal MLP, the company reported an 87% EBITDA margin in 2011. If the required yield to hold NRP were to drop to 9.0%, the total return would be about 25%.
With regard to Oxford, yielding close to 22%, it's a small producer and it recently announced that a 10% customer is defaulting on its commitments. This is a heavy blow. Still, to the company's credit, it has slashed distributions to subordinated note holders while maintaining the common distribution. How long this can last is an open question. Rhino is also a small producer and it is the only MLP of the four mentioned that cut its distribution. Until there's better visibility in the market, Oxford and Rhino are difficult to recommend.
Sticking with Alliance and NRP is not only safer, but the total returns are quite compelling.
MockingJay2011 owns shares of Alliance Resource Partners, L.P. and Natural Resource Partners LP. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Alliance Resource Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
