Digging Up For Coal -- NRP vs ARLP

Quick question: which company is more fairly-valued? ARLP or NRP?

Note that I'm not saying they're fairly-valued, undervalued or overvalued. I'm asking which one, relative to each other, is more appropriately valued, even if not so on an absolute basis.

Natural Resource Partners (NRP) is a coal property lessor, currently trading for $21 for a total market cap of $1.5B with a P/E of 14 and a dividend yield of 10%.

Alliance Resource Partners (ARLP) is a producer and marketer of coal, currently trading for $37, for a total market cap of $1.4B, with a P/E of 12 and a dividend yield of 8%.

Both companies are limited partnerships, thus required to pay out substantially all of their cash flows in dividends every quarter.

Now, what's your answer?

Okay, I didn't give you enough information. Fair enough.

My point is that nothing you can fish out of Google Finance or ratios from Reuters or Morningstar will make answering this question any easier.

This is because exploration companies such as NRP and ARLP are a special category of business. Their fair value depends heavily two things: a) the price of coal and b) their proven reserves.

For this exercise, we can ignore the price of coal, since we're talking about relative value here. If the price of coal changes, it will change for both companies.

Now, proven reserves. That's the amount of coal in the ground that is available for mining. This is a determinant factor because even if one company can extract coal more cheaply than the other, due to it having better technology, cheaper labor or being closer to cheap transportation, this fact may still be irrelevant on the long run if one company will live three times as long as the other one.

Consider this: As of December 31, 2008, NRP owned or controlled approximately 2.1 billion tons of proven and probable coal reserves, while on the same date, ARLP had approximately 686.3 million tons of proven and probable coal reserves.

So, it looks like NRP is the one that may live three times longer and distribute more of their cash flows to shareholders over the long term.

While this simple analysis does not answer the question, it brings up an important point to consider when dealing with exploration companies: the value of their proven reserves.

The real answer requires a little bit more "digging" (pun intended), but not in the ground; rather in the balance sheet of the companies. In specific, how accurately are the proven reserves reflected in the balance sheet? Also very important is the companies' capitalization structures -- how much debt they have, since interest on debt gets serviced ahead of common shareholders.

I'll leave this as an exercise for the reader for now. But unlike high school books, I will answer this question eventually in a future post. Stay tuned.

Disclosures: None

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