PVR Partners LP (NYSE:PVR) is making a change from coal to natural gas pipelines. This shift coupled with the still weak coal market has left the market concerned about the limited partnership’s distribution. Management, however, seems pretty confident that it won’t be an issue.
Out with the Old
PVR Partners LP (NYSE:PVR)’s history in the coal industry dates back to 1882. Up until a few years ago, coal was its primary business. The company doesn’t mine coal, however, it only leases coal properties. So, it doesn’t take on the inherent risks of running a coal business. It’s more of a toll taker.
That makes the company’s coal operations particularly high margin. However, coal is facing a number of headwinds. Coal is largely considered a dirty fuel source, which pits environmentalists against it. Also, electric utilities are the primary customers for coal, and new environmental regulations have made it increasingly more expensive to run and build coal fired plants.
More recently, new natural gas drilling techniques have resulted in gas prices falling to historic lows. With gas now competitively priced versus coal, more utilities are switching to cleaner burning gas. With reduced demand, coal prices have fallen. A double whammy that has left the coal industry, including PVR Partners LP (NYSE:PVR), struggling.
In with the New
Seeing the writing on the wall several years ago, and looking to diversify away from coal, PVR Partners LP (NYSE:PVR) started leveraging its coal assets to build a natural gas pipeline business. A logical step since coal provides such wide margins.
In fact, Natural Resource Partners LP (NYSE:NRP) is doing something similar. Although this coal leaser is still highly committed to coal, it has been branching out into other natural resource categories. A key difference, however, is that Natural Resource Partners LP (NYSE:NRP) is keeping its focus on owning properties that it leases out. So it has purchased land that can be drilled by others for natural gas, but it isn’t turning into a pipeline company.
That key difference could make PVR Partners LP (NYSE:PVR) a less risky long-term investment because it won’t be as dependent on commodity prices. That said, PVR Partners LP (NYSE:PVR) is making a big business shift. It is one thing to lease out coal properties and a totally different thing to own and build natural gas pipelines. Of course the company has made good use of acquisitions to quickly build this business, but that can just increase the complexity of changing gears.
A Dividend Cut
Based on PVR’s lofty dividend yield, the market isn’t convinced it can make the shift and maintain its distribution. That shouldn’t be surprising, since it hasn’t covered its distribution comfortably for a little while and there has been some weakness in both its coal and pipeline businesses. And there is a precedent for a dividend cut.
Inergy, L.P. (NYSE:NRGY) made a similar shift, moving from its legacy business of propane distribution to natural gas pipelines. Along the way, it undertook several corporate transactions that, in hindsight, seemed to make the move more complex then needed.
First it built a pipeline business. Then it spun off most of its pipeline assets to Inergy Midstream LP (NYSE:NRGM), leaving Inergy holding the legacy propane business and a stake in Inergy Midstream. Then it sold the propane business to Suburban Propane Partners LP (NYSE:SPH). This left Inergy with few assets and its ownership in Inergy Midstream. Essentially it is now the general partner of its independent midstream assets. A large dividend cut came with all of those transactions, leaving Inergy unit holders to wonder if it was all worth it.
A Different Tale
PVR doesn’t appear to be heading down the same path as Inergy. However, management has publicly stated that it doesn’t want to grow the coal business. That leaves a spin off or sale on the table, since the business is, effectively, a depleting asset if PVR doesn’t expand its property portfolio.
That said, so far this year the CEO has purchased 25,000 shares of PVR on the open market, with smaller purchases made by the CFO, General Counsel, and a company director. Such open market purchases are a vote of confidence in a company’s future. Moreover, the company has continued to increase its dividend in recent quarters, which is also a sign of support.
A Worthwhile Risk
While there is always the risk of a dividend cut when a company makes a big transition, PVR has a high quality asset base and numerous internal expansion efforts under way. With such a high yield, it is a worthwhile investment for those willing to bet with management that the shift to natural gas pipelines makes PVR a stronger company over the long term.
The article This Company Is Changing Its Stripes originally appeared on Fool.com and is written by Reuben Gregg Brewer.
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