Description

Natural Resource Partners L.P (NYSE: NRP) may be the cheapest name I have ever come across. Based on a normalized coal price environment in 2024/2025 (i.e. in-line with 2017-2019 pricing), I believe the company is set to generate $13-17 of FCF/share exiting 2025. This is a 29-40% FCF yield on today’s price at a time when the company is generating run-rate FCF/share of ~$25. Moreover, there is a significant event angle regarding a hidden asset. The company owns 49% of a soda ash mine and the owner of the remaining 51% is a publicly traded entity that has received a strategic bid for the company. To reiterate this point, NRP owns the exact asset that currently has a bid from its controlling shareholder, yet investors have yet to recognized this. For NRP, this minority asset is worth ~75-100% of today’s market cap, but only accounts for 14% of current run-rate FCF.

Business Description:

NRP is a natural resource company headquartered in Houston, TX that owns, manages, and leases properties to mine operators. These properties mainly consist of coal, industrial minerals, and other natural resources. Additionally, they own a stake the world’s lowest cost soda ash asset.

These are two very distinct business segments; Coal Royalty and associated revenue makes up ~87% of pre-corporate EBITDA (based on our 2022 estimates) and Soda Ash makes up the rest.

Coal Royalty and Associated Revenue:

The coal segment is comprised of mineral rights ownership interests where both metallurgical (“met”) and thermal coal is mined. NRP does not mine, drill nor produce the underlying minerals. They simply lease the underlying land/mineral rights in exchange for royalty revenue and other fees. Their land consists of about ~13mm acres of mineral interests and other rights across the US, primarily located in the Appalachian Basin, Illinois Basin (“ILB”) and Powder River Basin (“PRB”). About 2/3 of leases have an initial term of 5 to 40 years and the average lease term for their met coal business is about ~10yrs and ~3yrs for thermal coal business. With respect to splits, about ~50% of volumes and ~70% of sales come from met coal and the rest from thermal coal. Met coal is the main input in the production of steel globally and steel grows at a GDP minus 0-2% rate over a cycle. Most of the NRP met coal serves the domestic market, but during periods of heightened pricing (as we are in today), we see more and more of the met coal make its way to the export market. Conversely, thermal coal is used predominantly in coal fired power plants. Historically, thermal coal production has declined at a ~4% clip due to coal plants closures and renewables displacement.  Going forward, I expect thermal coal to decline at a low single digit rate, but NRP is a bit better positioned given a) its exposure to the Illinois Basin, which is the lowest cost basin in the US, b) within the Illinois Basin, its exposure to Foresight, a company that recently restructured to become a tier 1 cost asset, c) its exposure to tier 1 & 2 cost assets in the Appalachian Basin and d) its PRB production is co-located with a utility (although I do believe that will decline as we move to 2025+).

What makes this business significantly better than a coal company is the ability to produce FCF through an entire cycle. Royalties are generally based on a % of gross revenues received by the lessee for the sale of thermal and met coal. By our estimate, this is around ~5% of the entire book of business. However, the royalties are supported by a floor price and a minimum payment obligation during periods of price or demand declines. This makes this business significantly less volatile than the business of the underlying producers.

Source: Company Disclosure

In addition to royalty related revenue, NRP generates revenue from wheelage revenues (moving coal across its land), property tax revenues (taxes on the underlying property), CO2 sequestration revenues (legal rights to sequester carbon dioxide underground in approximately 3.5 million acres located primarily in the southern United States) and a few other ancillary streams  

Soda Ash:

NRP owns a 49% stake in Sisecam Wyoming LLC (“SW”), one of the world’s largest and lowest cost producer of soda ash. As can be seen in the organizational chart below, the other 51% is owned by Sisecam Resourced, an MLP (ticker: SIRE). SIRE is majority owned by Sisecam Chemical Resources, with ~20% of the float public. Sisecam Chemical Resources came about from the combination of Sisecam Chemical (Turkey Based) and Ciner (the old owner of the GP). This dynamic is important and will come back to it later.

As far as the as the assets themselves, SW is situated in the Green River Basin (“GRB”). The mining operations consist of ~23,500 acres of leased and licensed subsurface mining area. The GRB holds one of the largest and most pure deposits of trona ore in the world. Trona is a naturally occurring soft mineral and is the main ingredient in the production of soda ash. About ~30% of the world’s soda ash is produced by processing trona and the vast majority of the accessible trona reserves in the world are in the GRB. Trona production is the cheapest way to produce soda ash, giving NRP a sustained and material cost advantage vis a vis the global market. It is also much more environmentally friendly, consumes less energy and produces fewer undesirable by-products as compared to the synthetic production of soda ash (the other 70% of global soda ash production).

The demand for soda ash is driven by glass manufacturing (windows, containers, windshields, etc..), detergents, chemicals and green initiatives. Green initiatives are comprised of new LEED certified glass windows, solar panels for housing/commercial properties, production of lithium carbonate and lithium hydroxide which form the building blocks of lithium batteries used in EVs and battery storage. The combination of these green initiatives as well as an emerging global middle class, should drive overall demand for soda ash at a rate of GDP+; making this an attractive business long term.

Source: Sire Disclosure

Why are the assets mispriced:

Historically, was an overleveraged coal asset seeing a significant drop in volumes:

From 2015 to 2019, NRP saw nearly a ~50% reduction in the coal production of its properties. This was driven by a) coal plant closures, b) shift from coal to nat gas, c) bankruptcies of key customers and d) general economic weakness as China slowed its steel making production. This decline commenced at a time when NRP was carrying nearly $1.3bn of debt on its balance sheet. It’s no wonder this name has been shunned by investors over the years. However, despite this significant drop in production volumes, and speaking volumes to the strong FCF generation of the underlying business, NRP has worked tirelessly to de-lever and has reduced its debt from ~$1.3bn at the end of 2015 to our estimate of ~$169mm by the end of 2022. I expect NPR to be in position to fully pay down its debt by FYE’2024.

Source: Company Disclosure

Going forward, I believe the risks are significantly de-risked and our numbers have a huge level of conservatism built in for the following reasons:

1. As can be seen above, NRP has seen a resurgence in coal production of its properties. While part of this snapback has been driven by the move-up in coal pricing, most of the normalization is due to the fact that we are through most of the coal to gas switching and the exposure NRP has today is comprised of companies sitting at the low end of the cost curve
2. As a starting point, NRP properties are currently producing a run-rate of ~35.8mm tons of production (using Q3’22). However, for the entirety of 2022 I have them producing only ~33.2mm and going down to 32.3mm in 2023. I are already starting off conservatively
3. For our 2023-2025 estimates, I assume NRP thermal volumes decline ~3.5%/yr and met volumes are flat. My estimates for thermal are in-line with industry expectations, but my estimates for met coal are vastly below market expectations. For example, Jefferies’ Mining analyst believes met coal volumes in the US could be growing MSD next few years while I am modeling met volumes to be flat.
4. I give zero credit for certain lessees announced growth. For example, Ramaco Resources has announced a 1.7mm ton expansion (or ~5% of current volumes) in the Central Appalachian Basin. However, I am giving zero credit here for conservatism.

2017 issuance of Preferred Stock creates confusion and a drain on cash flows

Like the debt overhang, NRP issued $250mm of preferred stock in 2017 that carries an interest rate of 12.0%. This had four profound impacts:

1. Exacerbated the leverage issue by adding an incremental $250mm of debt like securities to the Balance Sheet;
2. Serves a significant drain on FCF as a ~12.0% interest rate amounts to ~$30mm of FCF/year;
3. Takeout provisions of the security dissuade NRP from taking out the preferred shares prior to 2024/2025. Doing so prior would lead to a sizeable premium being paid;
4. Accounting for the shares leads investors to believe the underlying dilution is much greater than the actual dilution from the shares

Source: Company Disclosure

With respect to the issuance of the notes, what is done is done. We can’t blame the company for looking to raise capital in 2017 at a time in which its coal volume dropped precipitously. However, the company has almost made it to the finish line. While they have been paying $30mm in cash (some in PIK interest) a year, I believe the company is well positioned to take the notes out by 2025 (only ~2yrs from today) at face value. Based on my estimates for FCF, I believe the company is positioned to take out any preferred shares that are converted prior to 2025 with cash. However, based on the mechanism of the conversion and NRP’s ability to pay in cash, I believe the unit holders are better off waiting to convert until 2025.

Moreover, funky accounting has clouded the actual dilutive impacts of the preferred shares. From 2022 to 2025, the “holders of the preferred units may elect to convert up to 33% of the outstanding preferred units in any 12-month period into common units if the volume weighted average trading price of our common units (the "VWAP") for the 30 trading days immediately prior to date notice is provided is greater than $51.00. In such case, the number of common units to be issued upon conversion would be equal to the per unit purchase price plus the value of any accrued and unpaid distributions divided by an amount equal to a 7.5% discount to the VWAP for the 30 trading days immediately prior to the notice of conversion.” In other words, the unit holders can only convert 1/3 of these units in any given year AND at a minimum conversion price of ~$47. However, the dilution accounting for the notes assumes full 100% conversion based on the quarterly average for the purposes of filing the 10-Qs/10-Ks. Post March 2025, the unit holders will be able to convert ~100% of their preferred shares but won’t have a chance as NRP will be able take out the preferred shares by then.

Carbon Sequestration Upside:

It is interesting to think that a coal company could benefit from the Inflation Reduction Act and other green initiates, but it appears that NRP is doing just that. Last quarter alone, they received $8.6mm in revenue for carbon neutral initiatives.  The company also issued a press release detailing an agreement with Oxy Low Carbon Ventures regarding the development of a sequestration hub on the 65,000 acres of pore space controlled by NRP. From a societal perspective, dramatic reductions in the carbon footprint of companies that have historically emitted significant levels of carbon can do more for the green energy initiatives than funding a carbon neutral company expansion. I am pleased that NRP is partaking in this initiative, and it may lead to significant cash generation in the years to come. If you also look at the Inflation Reduction Act in detail, there are significant subsidies for development of green energy on legacy coal sites. 

I believe the carbon sequestration business could add another $200 million in value, or another 35% upside to the stock price.  This analysis is based on new information the company has provided in recent quarters regarding leasing efforts and the revenue per ton potential.  Assuming the company can recognize this revenue over forty years and discounting the cash flow back, I arrive at significant value for NRP holders.  Of note, the below analysis solely considers acreage that NRP has already leased (140k acres of pore space) and does not include the additional 3.3mm acres of carbon sequestration rights across the gulf coast. While I am not underwriting anything regarding this opportunity into the future, it appears increasingly likely this will result in additional cash generation in the years to come.

Source: Company Disclosure, Author Estimates

The market is completely missing the value of the Soda Ash business:

As noted, NRP owns a 49% stake in Sisecam Wyoming LLC (“SW”). The other ~51% is owned by SIRE. The is the only asset owned by SIRE. Currently, SIRE carries a market cap of $446mm. While NRP is the minority owner, NRP is also not subject to the onerous GP/LP structure that SIRE is burned with. For example, current distributable cash flow at SW is ~$0.75/qtr. However, SW is currently paying out $0.50/qtr. The reason is that if cash flow ever steps up to $0.75/qtr, the GP of SIRE would be subject to a 50% payout. When factoring in that the controlling shareholder of SIRE is trying to buy out the company, it makes sense that the GP does not want to raise the distribution. More importantly, the illustration below (source: SIRE disclosures) shows that despite having ~51% share of SW, SIRE’s claim on SW cash flows is worth significantly less than NRP’s claim due to the IDR structure of the entity. For example, if cash flows improve from here to $1.25/share at SIRE (per quarter), the buyout bid only represents 76% of the 51% interest. Point being, I believe this alone is worth at least a 10% premium for NRP’s stake relative to SIRE’s fair market value.

The second market omission is that SIRE currently has a bid on the table from its GP to take out the remaining 20% that the GP does not currently own. While SIRE received a $17.90 bid, I think there is a good chance there will be a bump at some point in the future for three reasons:

1. The current GP bought its original ~60% stake in SIRE in the $30/share range
2. There are countless examples over the prior few years of GPs pursuing remaining LP interest and being forced to raise their bid 25%+
3. The independent conflict committee of SIRE is truly independent. None of them are associated with the GP and all of them own stock. I think they will likely take point #1 and point #2 into serious consideration
4. SIRE is currently trading at a significant discount to brownfield and greenfield projects.  In fact, SIRE is currenty valued at approximately $350/ton of capacity (assuming no GP split), well below two comparable projects that are moving forward (Note: Granger is a brownfield project).  If one were to value SIRE at the same EV/ton as the two projects below, NRP’s 49% ownership would be worth more than $700mm, or approximately $54/share 

The market has clearly factored some of this in as SIRE is currently trading at $22.12. Ultimately, I think we could see a bump to $25-$30. Regardless, I believe this asset is currently worth at least ~75% of NRP’s market cap and could exceed ~100% if SIRE receives a pay bump to $30/share.

Source: Company Disclosure, Author Estimates, Bloomberg

What is the asset worth?

I don’t have a crystal ball for what happens to coal pricing in the next 3 years and hence have not spent much time building conviction on that front (invariably I am likely to be wrong anyway). However, despite some pundits calling for ‘stronger for longer’ when it comes to many global commodities, my base case assumes that by the time we get to 2024/2025, coal pricing, both thermal and met, will normalize back to 2017-2019 industry averages. Layering our volume assumptions I laid out above for coal (which could be conservative) and assuming Soda Ash EBITDA is flat (also could be conservative), NRP should generate FCF of ~$185mm in 2025 as compared to the Q3’22 run rate of $320mm. While at first glance this would seem much greater than they have done in the past, it is important to remember that they are no longer carrying a massive debt load. For example, in 2016 they generated ~$174mm of unlevered FCF and ~$83mm of levered FCF.

In my base case, this amounts to FCF of $14.62/share. Additionally, I think their strong FCF generation enables them to buyout the warrants and preferred units as they come up for conversion (they are allowed to retire both for cash as they convert). However, I don’t believe preferred unit holders look to convert prior to 2025 and hence assume full paydown in 2025. For my downside case, I am assuming 2025 coal pricing 10% below 2016, while my upside case gives them credit for greater tonnage levels in 2025 given my commentary above.

Source: Company disclosures, Author Estimates

The bigger debate for us is what should the coal cash flows be worth. While I am not a coal bull by any means, I don’t see global steel as a declining industry given the continued growth of the middle class and the inevitable re-shaping/shift of global supply chains/infrastructure. Thermal is a declining asset but will still be with us for decades to come. However, the inherent stability of the business model does support a much higher multiple than one should ascribe to a coal related asset. By putting a 6-8x FCF multiple, or a 13-17% FCF yield, I am essentially arguing that the underlying cash flows of the company will still be around by the turn of the next decade.

Regardless, even using the lower end of our target 6-8x, after factoring in the value of the Soda Ash business, I believe the shares are worth 2-3x their current valuation.

Source: Author Estimates

ARTICLE DISCLOSURE

Disclosure: At the time of publication, the author of this article holds a position in NRP. This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a long position in the company covered herein and stands to realize gains in the event that the price of the stock increases. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use.  Any projections, forecasts and estimates contained in this report are necessarily speculative in nature and are based upon certain assumptions. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections presented. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

Soda Ash business appropriately valued by investors, pref repayment, and continued cash generation