Natural Resource Partners' Distribution Safe, Yield 11.5%!

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Natural Resource Partners, Up 10% Since Mid-December, Room For Much More

The last time I wrote about Master Limited Partnership, "MLP," Natural Resource Partners, (NYSE: NRP) was on December 11, [see here]. Since then the units are up 9% from $17.5 to $19.2, yet it continues to be a compelling story. Yesterday I wrote a piece [see here] on Alliance Resource Partners, (NASDAQ: ARLP). To invest for growth and a best in class business model, buy Alliance. But, I love NRP as well. A big reason for this update on NRP is that the company recently announced an acquisition. The following quote is from the company's December 20 press release,   

"...we acquired overriding royalty interests in the Marcellus Shale for $30.3 million. The acquisition was funded through the partnership's credit facility. The acquisition is on approximately 88,000 net acres located mainly in the liquids rich region of the Marcellus Shale.  The acreage is currently leased and includes established production as well as significant additional planned development potential. This acquisition continues to diversify NRP's revenues and expand NRP's unconventional oil and gas holdings, which currently include assets located primarily in the Marcellus Shale, Mississippi Lime, and Haynesville Shale plays."

Acquisition of Non-Coal Assets Speaks Volumes

Despite being a small acquisition for a company with a $2 billion market cap, I consider it to be a telling sign of management's view of the natural resources markets. Management is not afraid to invest in assets and Foolish investors should not be afraid to invest in NRP. Investing $30 million in cash is the last thing that management would do if it feared its liquidity or distribution was at risk. As I have said numerous times, NRP's annual distribution of $2.20 is safe. I believe it's safe through 2014, but that is only my opinion.

The great thing about an MLP yielding 11.5% when the FED's stated policy is to keep rates abnormally low for years to come is that there's no reason why that MLP can't yield 8%-9%. Since NRP is closely tied to the coal markets, it will always trade with a higher yield than more traditional pipeline and E&P infrastructure MLPs. However, as NRP diversifies away from coal-related revenues, its margin of safety improves. Looking forward a year, roughly one third of the company's revenues will be from non-coal reserve royalties. A year of two later, that figure may be a half.

NRP is Being Punished For Its Coal Reserve-Related Royalties

If NRP's operating model moves to 50% coal-related and 50% (E&P and Other, including building aggregates), then arguably half of its business should trade at a 6%-7% yield and the other half at a 9%-10%, for a company-wide yield of 8%. At 8% the implied unit price would be $27.5, about 42.5% above the current price. Add the current yield of 11.5% and the total return would be 54% over a 1 year horizon. If an 8% yield is achieved after 2 years, the total return would be 65%. I believe NRP units could provide a total return 65% over the next two years. Note, one would have to hold the units for 2 years to earn (11.5% +11.5% = 23%) of that 65%.   

Importantly, an 8% yield assumption is not overly aggressive. In April, 2011 the units traded as high as $37.5 for a distribution yield of 5.9%. Back then, roughly 85% of revenues were from coal reserve royalties. Therefore, all else equal, NRP should trade at a better valuation as it diversifies away from coal to safer investment assets. Of course, all is not equal when it comes to coal. It might be prudent to assume that the coal portion of NRP's business will grow on average just 2%-3% in coming years. But, if the increasing portion of non-coal reserve royalties can grow at 5%-6%, that's not a bad MLP to invest in.  

I also wrote a piece today [see here] about coal producers like Peabody Energy, (NYSE: BTU), Arch Coal, (NYSE: ACI) and Alpha Natural Resources, (NYSE: ANR). I think that investments in companies like these are far more volatile and won't deliver 2-year returns as high as 65%. Having said that, Alpha was up 30% in December. These coal stocks are not cheap. They may appear cheap because their stock prices are down 50%-60%, but debt levels are higher and earnings prospects dramatically weaker. Arch has $4.5 billion in debt, Peabody is struggling with rampant cost inflation in Australia and Alpha needs coking coal prices to rise by 20%, ASAP.

Two years from now, I believe (my opinion only) that NRP will be in the position to increase its distribution by 2%-4% a year. That doesn't sound like a lot, but many MLPs that currently yield 5%-7% have slow but steady distribution growth in that range. 

Foolish Bottom Line

With NRP one gets paid to wait for the market to become more comfortable with NRP once again, driving the required yield to own the units lower. In addition, investors are paid to wait for the company's business model to become less risky as it diversifies away from coal. In a world with 10-yr treasuries yielding 1.83%, I am convinced that yield-starved investors will find their way to NRP. An 11.5% yield will become an 8% yield and investors could pocket a total 2-yr return of 65%.              


MockingJay2011 owns shares of Alpha Natural Resources, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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