Business context and reporting period
Natural Resource Partners L.P. (NRP) filed this Form 10-K for the fiscal year ended December 31, 2010; it is an annual report, not a standalone fourth-quarter filing. NRP owns and leases mineral properties, principally coal, and generally earns royalties based on lessee production and sales. It does not operate mines. At year-end, it reported approximately 2.3 billion tons of proven and probable coal reserves and 228 million tons of aggregate reserves.
Fourth-quarter 2010 results, as presented in the filing’s unaudited quarterly data, were revenue of $77.5 million, operating income of $52.9 million, net income of $42.5 million and net income per limited partner unit of $0.39.
Financial performance and liquidity
| Metric | FY 2010 | FY 2009 | Change |
|---|---|---|---|
| Total revenue | $301.4 million | $256.1 million | Up 17.7% |
| Operating income | $196.1 million | $154.0 million | Up 27.3% |
| Net income | $154.5 million | $114.1 million | Up 35.4% |
| Net income per limited partner unit | $1.54 | $1.17 | Up 31.6% |
| Net cash provided by operating activities | $258.7 million | $210.7 million | Up 22.8% |
| Distributable cash flow (non-GAAP) | $227.0 million | $178.4 million | Up 27.2% |
Coal royalties were $221.8 million, up 13%; coal production was essentially flat at 47.1 million tons, while average gross coal royalty revenue rose to $4.71 per ton from $4.20. Coal processing and transportation revenue totaled $24.2 million. Aggregate royalties were $4.2 million, down from $5.6 million; oil and gas royalties were $7.7 million. The filing reports operating and net margins of approximately 65.0% and 51.3%, respectively, based on total revenue and reported income.
Cash and cash equivalents were $95.5 million at year-end. Total debt was $692.6 million, including $31.5 million current and $661.1 million long-term debt; year-end revolver borrowings were $94 million, with $206 million of facility capacity available. After early-2011 acquisitions, management reported $125 million of available capacity. Total assets were $1.664 billion and partners’ capital was $825.2 million. Operating cash flow funded distributions and a significant acquisition program: investing cash use was $170.8 million and financing cash use was $75.0 million.
Quarterly distributions remained $0.54 per unit throughout 2010, or $2.16 per unit for the year, unchanged from 2009. NRP reported that distributions are subject to available cash, reserves and debt restrictions and are not guaranteed.
Material changes versus the prior comparable period
- Revenue and earnings improved from 2009, helped by higher coal prices and per-ton royalties, increased Illinois Basin production, and a $12.9 million increase in minimum royalties recognized, primarily related to a non-recoupable Colt minimum.
- General and administrative expense rose to $29.9 million from $23.1 million, including higher incentive-plan accruals, staffing costs and $2.5 million of BRP formation expenses. Interest expense rose to $41.6 million from $40.1 million, reflecting acquisition-related debt and higher-cost notes.
- Appalachian coal production declined 4%, but higher royalty rates and prices lifted regional royalties 10%. Illinois Basin royalties rose 37%, with production up 16%. Aggregate production increased 34%, while royalties fell due partly to reversal of a $0.6 million bonus accrual.
- NRP eliminated all incentive distribution rights on September 20, 2010, issuing 32 million common units in exchange. Management expects the transaction to dilute cash available for distribution in 2011, while stating it should lower the cost of capital and support long-term growth. Common units outstanding were 106.0 million at year-end, versus 69.5 million in 2009.
- NRP formed BRP with International Paper, contributing $42.5 million for a controlling 51% income interest and a preferential cumulative annual distribution. BRP’s acquired reserve quantities and qualities were not yet fully analyzed.
Outlook, risks, contingencies and unusual items
Management said coal prices were stronger than forecast in the second half of 2010 and rose further in December and January, citing Australian flooding and global demand. With metallurgical coal representing 38% of coal royalty revenue, management expected to benefit from economic recovery and steel demand. This is commentary, not quantified earnings or distribution guidance. The filing states that acquisition and project timing is uncertain and that the Colt transaction could require a further $150 million through 2012 upon development milestones; an additional $70 million Colt acquisition closed in January 2011.
- Customer concentration: Cline Group contributed 20.7% of 2010 revenue, Massey Energy 14.2% and Alpha Natural Resources 12.0%. Cline’s Williamson mine alone represented about 10% of revenue. Lessee financial or operating problems, consolidation or mine closures could materially affect royalties.
- Gatling mine and impairment exposure: The Gatling operation was idled in April 2010. Its related assets had a $133.6 million net book value. Cline continued minimum payments, but NRP warned that failure to restart the mine or secure coal sales could change cash-flow estimates and lead to a material impairment charge. No impairment was recorded based on the analysis described.
- Regulatory and market risk: NRP cited increasing permitting delays and costs, mine-safety enforcement, water-permit constraints and potential air-emissions and greenhouse-gas regulation. These could reduce lessee production or coal demand. Coal prices, alternative fuels, weather, transportation and steel-market conditions also affect results.
- Debt and financing: The revolving facility matures in March 2012. Scheduled debt principal payments increase in 2013; the filing notes a $35 million senior note due that year. Debt covenants apply, and certain senior notes carry an additional 2% interest provision if leverage exceeds the specified threshold. A change of control would trigger a credit-facility default.
- Other contingencies and structural risks: Management considered ordinary-course legal proceedings immaterial and reported no material environmental charges against NRP, but acknowledged potential environmental exposure as a property owner if lessees cannot meet obligations. The partnership also disclosed related-party transactions and potential conflicts involving affiliates and major lessees.
- Unusual items: Minimum royalties recognized as revenue were $14.2 million, including a significant non-recoupable Colt payment. NRP recorded $4.8 million of minimum amortization for temporarily idled assets. The 2009 comparison included an $8.2 million depletion charge related to a terminated lease.
The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded that disclosure controls and internal controls were effective at December 31, 2010.
Key facts for investors to verify
- Whether production and coal sales at the idled Gatling mine resume, and whether NRP’s cash-flow assumptions continue to support the $133.6 million carrying value.
- Colt development milestones, the timing and funding of remaining committed purchases, and whether resulting production supports future royalties and distributions.
- Exposure to Cline, Massey and Alpha, including the Williamson mine concentration, receivable collectability and any effects of lessee consolidation.
- Current borrowing capacity, refinancing plans ahead of the March 2012 revolver maturity, debt covenant headroom and scheduled principal payments.
- Whether stronger coal prices and metallurgical demand persist, and how regulatory or permitting changes affect lessee activity.
- BRP reserve assessments and valuation completion, and the eventual income and cash contribution after its preferential distribution.
- The effect of the IDR elimination and increased unit count on per-unit distributable cash flow and future distributions.