Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
Triple net lease is a term used in real estate to describe a property owner that leaves all of the expenses to its renters. Realty Income (NYSE: O ) is a leader in this space. Natural Resource Partners (NYSE: NRP ) uses a similar approach in the coal industry, owning mines but avoiding the risk and expense of running them.
The Monthly Dividend Company
Realty Income owns around 3,600 free-standing single-tenant properties. The defining feature of the REIT's business model is the triple net lease structure, which leaves the tenant responsible for taxes, maintenance, and insurance. These are the main costs of owning a building, so, effectively, Realty is collecting rent and doing very little work.
That's a great model, and the success is clear from the fact that Realty has paid dividends for 44 years, with 73 dividend increases. In fact, it increased distributions right through the deep 2007 to 2009 recession that caused many other REITs to cut their dividends.
That downturn actually opened up opportunities for Realty, which has been improving the quality of its portfolio through acquisitions. Look for continued solid, low-risk performance and dividend hikes from this around 5.5% yielder with a simple business model.
What's this have to do with coal?
Running a coal mine is a pretty risky business. For example, looking at the annual report for Arch Coal (NYSE: ACI ) provides a laundry list of "risks" to consider: fires, explosions, cave-ins, floods, existing mining regulations, new mining regulations, disease (Black Lung), coal transportation...etc. If you take the time to read the list, you'll probably ask yourself why anyone would want to own and run a coal mine.
That's particularly true today, with coal prices and demand depressed. However, coal mining is a highly leveraged business. There are significant fixed costs, but once coal sales cover those costs profits fall quickly to the bottom line. For example, in 2011 the company sold 155 million tons of coal for $25.34 a ton. The total cost of getting that coal out of the ground and into customer hands was $21.68, leaving the company with $3.66 per ton.
The next year was far more difficult, the company sold about 141 million tons for an average price of $25.90. However, partially because of the lower volume, its costs rose to $24.17 per ton—same mines but less coal sales over which to spread its costs. The company only made $1.73 per ton. That's a 50% drop on a 10% volume decline. Clearly there are other factors involved, but the year-over-year results show the inherent leverage of running a coal mine—just in the wrong direction.
And, unfortunately for Arch, the coal market has only gotten worse so far in 2012. So that leverage is still working against it. Earnings will be bad this year, but should start to perk up in 2014 when the U.S. coal market looks likely to strengthen. For aggressive investors, now could actually be a good time to jump in.
That positive leverage potential may not be enough to entice you if you are risk averse. In that case, Natural Resource Partners offers an interesting alternative. The company owns coal mines, but it doesn't run them. Natural Resource Partners lets its lessees take care of the expense and risk of mining while it sits back and collects royalties.
Basically, it's renting out its coal mines just like Realty Income rents out its buildings. It earns royalties based on the coal sold from its properties, so 2013 has been a rough year on the coal side, with a nearly 20% increase in coal production still leading to an 8% drop in coal royalty revenues because of lower prices. That, however, is good compared to coal miners like Walter Energy (NYSE: WLT ) and Alpha Natural Resources (NYSE: ANR ) .
Walter sold 14% less coal in its core metallurgical business in the second quarter. And despite reducing costs by 10% it lost $0.55 a share compared to earnings of $0.51 last year. The six month results were even worse. This year is going to be a really bad one for Walter, and met coal will probably take longer to recover than thermal coal, so a rebound may not appear until the back half of 2014.
Alpha, meanwhile, saw its coal volume fall nearly 20% in the second quarter and its margin per ton cut by more than half. It has now lost money for seven consecutive quarters. Like Walter, the year-to-date results were even worse. However, with a much larger thermal business, Alpha could start to see improvement on the bottom line in early 2014, if not sooner.
Avoiding the drama
Costs were a big issue for Alpha and Walter, just like they were for Arch. Natural Resource Partners, not so much—it let its lessees deal with cutting costs. It just kept track of the coal coming out of its mines. That's a big business model shift and one that could make buying a coal mine owner worth the risk if you are conservative but still like the turnaround potential of the coal industry. And with a yield of over 11%, you'll be paid well to wait for an industry upturn.
More ideas from The Motley Fool
Interested in natural resources? Then you owe it to yourself to discover the most precious resource in the history of the world. It's not gold. Or even oil. But it's more valuable than both of them. Combined. And here's the crazy part: one emerging company already has the market cornered... and stands to make in-the-know investors boatloads of cash. We reveal all in our special 100% FREE report The 21st Century's Most Precious Natural Resource. Just click here for instant access!