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Gamble of the week: a risky bet on coal
Royalty trusts might look enticing as a sector, says Alex Williams. But it's best to keep your distance.
Usually in this column we like to trackdown high-risk stocks that we believemight just surprise the market on theupside, and so deliver outsize returnsto brave investors. But this week wewant to warn you away from a sectorthat we know might look temptingto contrarians, but is more thanlikely a "value trap".
Royalty trusts companies that own the right to a mineor oil well's production, without beinginvolved in the mechanics of getting itout of the ground became popular inthe 1950s as a corporate-tax strategy.Hiving off a royalty over a company'slargest coal or oil fields was a goodway to syphon off profit into a tax efficientvehicle.
Today, the sector looks enticing, withhigh yields on offer. But beware:returns tend to exaggerate the commodity cycle. BP Prudhoe BayRoyalty Trust, for example, collectsroyalties from BP's oil fields in Alaska.Its shares have fallen by 90% since2011, exaggerating the drop in oil andgas. And of all the commodities thathave suffered in the crash, few havedone as badly as coal. That's left coal focusedroyalty trusts looking verycheap indeed.
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Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
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For example, Houston-basedNatural Resource Partners LP (NYSE:NRP) is trading on an estimated price/earnings ratio of just 1.5 and a dividendyield of 31%, according to Bloomberg.Sounds tempting. But we'd avoidit. NRP has royalties over 2.3billion tonnes of coal in Illinois andAppalachia, but as commodity priceshave dived, it's tried to diversify, saysReuben Gregg Brewer in the MotleyFool. Coal made up 94% of its earningsthree years ago. A concerted push intooil means that dependence has shrunkto around two-thirds.
Unfortunately,the expansion drive also means debthas "ballooned" from $840m to $1.4bn just as oil prices joined coal pricesin falling off a cliff. Interest paymentshave more than tripled to $89m ayear, eclipsing dividends last year forthe first time. Just $13m remains ofthe corporate credit facility, forcingmanagement to sell off assets in coaland aggregates at the bottom of themarket. As Brewer sardonically puts it:"If you are looking for tax losses, thiscould be a good candidate."
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