Is there a business sector more despised than coal? Tobacco, possibly, but even that’s debatable.
The anti-coal campaign has been funded and forwarded mostly by the federal government. The Environmental Protection Agency (EPA) has long served as lead myrmidon.
The EPA has been relentless. Its latest salvo, Clean Power Plan, discourages the use of coal for electricity production. If implemented, the plan would drop coal’s percentage of electricity generation to 25% from 39%.
Great, you might think. After all, coal produces more carbon dioxide than natural gas, wind or solar.
Well, it’s not so great. Coal is the cheapest fuel for electricity generation. The production costs of coal-fired power plants are nearly half that of its chief competitor. A coal-fired plant averages $0.0324 per kilowatt hour compared to $0.0644 for a new natural gas-fired plant. Americans would pay a huge price for a negligible reduction in the world’s carbon dioxide emissions.
The EPA’s war on coal has led to many causalities. Huge losses in shareholder value have occurred over the past five years.
|Coal Company||Five-Year Share-Price Depreciation|
|Peabody Energy (NYSE: BTU)||92%|
|Rhino Resources Partners (NYSE: RNO)||92%|
|Arch Coal (NYSE: ACI)||97%|
|Alpha Natural Resources (NYSE: ANR)||98%|
|Walter Energy (NYSE: WLT)||99%|
Income, not surprisingly, has gone the way of shareholder value. Dividends across the coal spectrum have been slashed or eliminated.
With that said, I have yet to throw in the towel on coal. It is too important of an energy source. Coal satisfies 30.1% of global primary energy needs (second only to oil), generates over 40% of the world’s electricity, and is used in 70% of the world’s steel production. Economics tend to trump politics in time.
I have also yet to throw in the towel on income derived from coal. Specifically, I’ve yet to give up on Natural Resources Partners (NYSE: NRP).
NRP isn’t your typical U.S. coal-mining company. For one, its primary business isn’t mining. NRP is organized as a royalty trust. It owns coal, oil and gas, and aggregate and mineral properties. It leases these properties to other companies to mine. NRP collects a royalty on production. I like NRP’s model because it avoids the risk associated with large investments in fixed assets used in direct mining.
I also like that NRP still pays a distribution (albeit a reduced one). At the current annual payout of $0.36, NRP units yield 9%.
To be sure, coal is a tough business, mostly due to regulatory overreach. But not all coal is alike. Sixty-six percent of NRP’s coal properties produce thermal coal – the stuff that powers utility plants. Thirty-four percent is metallurgical coal. This is the stuff used to fuel steel production, an energy-intensive endeavor. There is no substitute for metallurgical coal in steel production.
Diversification also mitigates risk. A few years ago, NRP was all about coal. Today, that’s no longer the case. Roughly 42% of NRP’s expected $490 million to $535 million in projected 2015 revenue will be generated from coal. Roughly 43% will be generated from aggregates (used in asphalt and concrete production) and industrial minerals. Oil and gas will account for 12% of expected revenue.
Admittedly, NRP has been hit by the perfect storm. Prices for all its commodity-producing properties have tanked over the past couple years. The good news is that recent price activity points to a bottom. A cyclical upturn isn’t beyond reason. Europe appears to have re-engaged growth and China is again showing an appetite for commodities.
In April, NRP reduced its annual distribution to $0.36 from $1.40. Investors responded by dumping NRP units. Interestingly, NRP expects to generate $175 million to $200 million in distributable cash flow this year. This is more than enough to cover the old distribution.
Why, then, the distribution reduction?
The $130 million saved each year will be used to reduce debt. In five years, NRP expects to reduce its $1.46 billion debt burden by a third. This is a smart conservative move for reducing financial risk and maintaining long-term viability during difficult times.
I’m an unrepentant contrarian by nature. I view NRP as one of the better contrarian plays on the market. I don’t see any further reduction in the distribution, but I do see considerable price- appreciation potential in this coal investment when energy prices recover and economic growth returns.
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