Coal focused Natural Resource Partners (NYSE: NRP ) recently announced plans to sell $300 million worth of bonds to permanently finance its purchase of a stake in a soda ash producer. With interest rates still near historic lows, locking in current rates through 2021 is a good call. But, debt is getting a little high at around 80% of the capital structure, particularly in light of the weak coal markets which still account for around 70% of revenues.
Natural Resource Partners isn't exactly a coal miner, instead owning coal lands that it leases out to miners. Thus, it earns royalties and almost completely avoids the costs and risks of running coal mines. So, with few expenses, Natural Resource Partners can afford to take on more debt than competitors that do their own grunt work.
For example, Rhino Resource Partners (NYSE: RNO ) has long been debt averse. Its general partner chose to stop receiving distributions on its subordinated units and trimmed the limited partner distribution slightly so it could continue to fund expansion within and beyond coal. Debt at Rhino is just about a third of the capital structure. The partnership, meanwhile, is pushing into natural gas and oil drilling and has an expansion project in the relatively low cost Illinois coal basin.
The decision to cut distributions is, on the surface, concerning. However, continued expansion and the maintenance of a low debt profile give Rhino a great deal of flexibility during a very rough period for coal miners. Rhino's diversification efforts are only just beginning compared to Natural Resource Partners, which generates around 30% of its top line from non-coal-royalty businesses. But of the two, Rhino's capital structure looks more capable of handling additional diversification efforts.
Rhino yields around 14% and Natural Resource Partners 11%. Neither is a low risk investment, but investors need to ask how much further Natural Resource Partners can push its debt load without overburdening itself. To be fair, the soda ash purchase was large and opportunistic, but any more big purchases could put distributions at risk if coal markets continue to struggle.
What debt can do
Walter Energy (NASDAQOTH: WLTGQ ) is a good example of how damaging debt can be. Long-term debt accounted for about 75% of the metallurgical-coal-focused miner's capital structure. It recently had to trim its dividend to a token penny a share and amend a credit facility to improve liquidity. While those were clearly the right moves in a difficult market, debt is a burden that doesn't easily go away.
For example, Walter was able to cut its capital spending essentially in half in 2013 to reduce costs but it's debt expense of $53 million per quarter won't go away without repaying or refinancing. With sales under pressure, debt ate up 10% of sales in the first quarter and 12% in the second quarter. It's little surprise that the dividend had to be cut.
Walter is projecting coal volumes to be down about 6% year over year. Couple that with price weakness in the met market and the company's weak first half is going to turn into a weak 2013. Natural Resource Partners isn't in that boat. A near 20% increase in coal production at its mines in the first half helped mitigate a nearly 25% drop in its per ton royalty payments. And, perhaps more notable, the 15% growth in revenues at its non-coal-royalty businesses left the top line down just 1% year over year.
Diversification is good
So the good news is that Natural Resource Partner's diversification efforts clearly look to be working. On the other hand, those efforts could be set to slow if coal markets don't perk up. And the best laid plans don't always pan out. PVR Partners (NYSE: PVR ) is a great example.
The partnership has been moving away from its coal royalty business for years, using it as the building block for a shift into natural gas infrastructure. This transition sets the company up to benefit as natural gas increasingly competes with coal for base load electricity generation. It's clearly a good strategic move to be in a position to benefit no matter which fuel source wins.
However, this year has been tough on PVR. It's coal business has been performing generally in line with expectations, but results at its pipeline operations have been weak. Although the partnership expects to meet its pipeline volume targets by the end of the year, it is taking longer than expected to ramp up. That could present investors with a buying opportunity, however, since the shares have sold off about 20% since the middle of July and now yield nearly 9.5%.
Still, PVR's troubles in its "new" business highlight the risks inherent to a changing business profile. While Natural Resource Partners' "new" businesses appear to be doing just fine, that clearly isn't a guaranteed result. With debt at relatively high levels, investors should be paying increasing attention to how well Natural Resource Partners' non-coal businesses are running.
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