Is Coal Or Gas Dragging Down This LP?

Of all of the companies using a coal legacy to shift into natural gas and oil assets, PVR Partners (NYSE: PVR  ) is by far the furthest along. Despite that fact, the partnership's distributable cash flow (DCF) wasn't enough to cover its over 9% distribution. Is the partnership's coal legacy the problem or is the issue its natural gas assets?

In 2011, coal royalties made up almost two thirds of PVR's revenues. Last year that number had fallen to about 20%. The rest comes from pipelines. That's a big change and makes the partnership more of a pipeline company than a coal play.

The power of diversification
There are others following a similar path. For example, Natural Resource Partners' (NYSE: NRP  ) coal royalty business represented 90% of its top line in 2005 but today is around 70% of the total. The rest comes from mineral interests, coal handling facilities, oil and gas interests, and a soda ash business. Growth of around 15% on that side of the business, plus increased coal volumes, helped the company almost completely offset a 25% decline in the price of coal.

Although revenues falling just 1% in the first half is relatively impressive in a weak coal market, the company's reduced second half guidance sent the shares lower. The stock yields around 11%. Although the second half is likely to be relatively weak compared to 2012, Natural Resource's diversification efforts are paying off and should position the company well for long-term growth. More aggressive income investors should take a look.

PVR's efforts, meanwhile, were supposed to lead to not just more diversification, but growth as well . That looked like the case from 2009 to 2011, when the top line grew from about $650 million to nearly $1.2 billion and led to a resumption of distribution hikes in mid-2011. However, weak coal markets in 2012 led to a top line decline of around $150 million last year. Coal volume was down over 20% and royalties per tonne were down about 10%, leading the coal business to a revenue drop of around 30%.

Don't blame coal
It's no wonder that the coal business has left PVR with something of a stigma. However, so far this year, the coal business is performing in-line with management's projections. In fact, on the second quarter earnings call, management indicated that it expects coal to be in line for the entire year, as well. Coal isn't the problem today, it's the pipelines.

The company's pipeline volumes, augmented by last years Chief Gathering acquisition, rely on the timing of wells getting connected to the system. That didn't happen as expected in the first half and the top and bottom lines were soft because of it. Moreover, a water pipeline going to drillers hasn't seen as much demand as expected.

Worse, the partnership has kept the distribution static so far this year after eight sequential quarterly increases. Although PVR expected to fall short of covering its distribution this year, investors weren't expecting the weak first half showing and are always displeased when distribution growth is interrupted.

A few wells can make a big difference
Rhino Resource Partners (NYSE: RNO  ) , which is using its coal business to get into the natural gas and oil drilling space too, shows just how important a few wells can be. Although drilling only represents about 2% or so of the partnership's sales, adding just 10 new wells in the second quarter led to a nearly 300% increase in revenues on that side of the business.

As a relatively small partnership, that type of growth offers more aggressive investors notable upside. And, Rhino is scheduled to open a new mine in the middle of 2014 that already has purchase agreements in place. Rhino is also among the least leveraged coal plays.

While the rest of the year should be relatively weak, 2014 could turn out to be a good one for the company, even if coal doesn't bounce back. Although the 13% yield is concerning, aggressive income investors should take the time to examine this LP.

Timing is everything
For PVR, meanwhile, Rhino's big revenue jump from just 10 wells should offer some solace. PVR believes the wells that didn't get hooked up are just delayed, not gone forever. And it is expecting to hit its pipeline volume numbers before the year is out. That's not likely to happen soon enough to turn 2013 around, but it will lead to a solid start for 2014. Not least of which will be particularly easy comparisons in the first half of the year.

While PVR's swoon has left it yielding north of 9%, that won't last long as pipelines get added to its system and results start to improve. Although not strictly a coal play, this is an interesting option for income investors to benefit from a coal turnaround and a notable, but slow growing pipeline business.

For those looking for a coal play with less diversification, however, Natural Resource Partners is a good high-yielding call. Rhino, meanwhile, probably has more upside as it grows its drilling business from a small base and within a smaller company.

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