Welcome to Episode 94 of Special Situation Investing.
Last week, my cohost and I spent hours discussing hard asset, asset-light businesses. Our research over the past few years has us convinced this corner of the market offers tremendous long-term value. As we continue to hone this thesis, our portfolio construction has slowly grown to reflect our conviction.
Our conversation on the subject was prompted by a question from one of our dedicated newsletter readers. Our friend asked why one should consider buying Permian Basin Royalty Trust when the fundamentals of Natural Resource Partners appeared more appealing. Our reply contained a handful of thoughts. One of which was how we view our investments in hard asset, asset-light businesses as investments in a thesis at least as much as we consider them investments in individual companies. We said:
[Part of the answer] has to do with how we are investing in a thesis more so than any individual company. We have high conviction that the niche of companies with hard asset, asset-light business models stand to outperform over the next decade or so. We have much less conviction that we (with our lower than average brains) will be able to select the one or two winners within that niche. So we are comfortable holding a couple handfuls of these great businesses.
We have a few thoughts to add to that comment. First of all, while we currently find a lot of value in this asset-light niche, it’s not the only area we are invested nor does it consume all of our time. We are sector agnostic, hunting for inefficiencies and value wherever we can find it.
Second, our quote above states we believe this niche stands to outperform for a decade or so, but in all likelihood, it could be much longer than that. One has only to look at the performances of such diverse companies as Moddy’s, Monster Energy, and security exchanges to realize asset-light businesses can outperform for many decades. We believe these companies dovetail nicely with our mindset of multi-generational investing that we wrote about in our pieces The Century Portfolio and Wealth is the Control of Time. We intend to hold many of our positions until we pass or until we pass them to our children.
Lastly, while thinking in terms of investing in a thesis has led us to acquiring more than a few companies that meet our criteria, it hasn’t kept us from concentrating in ones with particular advantages and greater upside. The best example is Texas Pacific Land Corporation. This company holds a central position in our portfolios due to its unique advantage of outright fee simple ownership of its land. This is in contrast to most royalty companies that own certain rights (i.e. minerals, royalty, and or water etc.) but don’t own the land itself. TPL controls almost 900,000 acres in one of the greatest oil basin in the world. It’s a valuable, unique and perpetual asset. Another reason we often chose to concentrate more capital to one of the companies within this thesis over others is because it is particularly undervalued or due to an approaching catalyst.
As we wrap-up this longer-than-expected intro, we are going to move on to discuss a few updates from two companies that we’ve recently allocated to for these very two reasons—Natural Resource Partners is massively undervalued and Mesabi Trust will soon benefit from a significant catalyst. A couple updates from the latest quarterly reports explain why.
Natural Resource Partners
Since 2015, Natural Resource Partners (NRP) has been on an aggressive campaign to de-lever and de-risk. Its journey began from a position of $1.5 billion in debt and $144 in annual free cashflow and the NRP of today is positioned totally different with only $385 million of total liabilities and a record TTM free cashflow of $308 million.
Reading through the company’s quarterly report and conference call we pulled out a few highlights we found particularly interesting.
First, we were encouraged to see an additional $81 million of NRP’s 12% preferred equity was retired with cash over the last quarter. This increased the total preferred equity retirement for the year to $128 million and lowered the outstanding balance of preferred equity to $122 million. Total obligations including debt, preferred equity and warrants decreased over 10% since last quarter. The chart below shows total obligations at a new low of $385 million as the company continues to pursue reducing its total debt to zero.
Free cashflow was another point of interest. In Q2, NRP delivered $82 million of free cash flow well above the $64 million produced in Q2 2022 and also above the $73 million in FCF from one quarter ago. While this sounds exciting, it’s important to note that $21 million of FCF was from an early payment of the second quarter distribution from NRP’s stake in Siescam Wyoming. The company explained:
[W]e received an $11 million quarterly distribution related to the first quarter performance and a $21 million distribution related to the second quarter's performance. In the past, we received quarterly distributions from Sisecam Wyoming approximately two months following the end of each quarter.
So the company essentially reported $21 million in FCF that would normally be included in next quarter’s results. Subtracting out the early payment leaves a quarterly FCF of $61 million which is a decrease from both last quarter and a year ago. This is primarily a result of lower coal prices. We are hopeful that those prices are now building in a bottom having recently risen 24% from $124/ton to $160/ton. But who knows, we’re not macro guys, and the macro guys don’t know either.
There was one more note worth highlighting about the the company’s investment in soda ash. Craig Nunez, the company’s CEO, made this comment about the soda ash market:
Softening soda ash demand coupled with new capacity from China has recently caused a significant drop in spot prices, which is likely to weigh on results for Sisecam Wyoming in the second half of the year.
What we found interesting was within days of that comment, the price of soda ash rocketed up 43% to a new 52-week high. We don’t know enough about the soda ash market to know what caused the rise (we intend to do further research into that market) but are interested to see if the price remains high and how that will increase NRP’s dividends from Sisecam Wyoming.
Overall, we were pleased with NRP’s continued progress and maintain our bullish opinion that it remains undervalued even after its recent upward climb. You can check out our previous piece with back-of-the-napkin valuation calculations here: Another Look at Natural Resource Partners.
Mesabi Trust
Mesabi Trust is another company we’ve discussed at length in previous pieces. It shares the characteristics of a hard asset, in this case iron ore, asset-light royalty business. This stock became a special situation as over the last year when its mine operator, Cleveland Cliffs, idled operations in protest over the premium royalty it is required to pay to the Trust. As a result, Mesabi Trust was forced to paused its dividend causing its stock price to decline. But the situation is improving. In April, Cleveland Cliffs slowly restarted operations on Mesabi’s mines. The company’s CEO made the following remark in the Q1 conference call:
Our higher levels of steel production have led to the partial restart of some operations at our iron ore mining and pelletizing swing facility at North Shore earlier this month. As you may recall, North Shore has been totally idle since the spring of last year. We will continue to treat that facility as our swing operation. And at this time, we still do not expect to operate North Shore in full any time this year.
While it may not be fully operational, it appears that Cleveland Cliff’s operations are almost back to where they were before the idling. This is evidenced by the amount of ore shipped or produced within the last quarter. Mesabi’s most recent SEC From 8 reported the following:
In the second calendar quarter of 2023, Cliffs credited Mesabi Trust with 886,301 tons shipped or produced during the quarter, as compared to 198,495 tons shipped or produced during the second calendar quarter of 2022.
A dive into Mesabi’s records revealed that the average tonnage produced or shipped credited to Mesabi was 1.15 million tons per quarter prior to the mine’s idling last year. This data is shown in the chart below. Note: to calculate the average, negative outliers and two quarters where data was unavailable were excluded.
The recent total of 886,301 tons is 77% of the average from between Q1 2018 to Q1 2022. We’re watching closely to see if tonnage returns to normal levels. The timing is never certain with these things. While recognizing the human tendency is to believe good things will happen sooner than they do, we believe Mesabi Trust is close to reinstating its dividend. Once that occurs, in addition to getting a high percentage dividend at today’s stock price, we believe the stock could rerate higher. As such, we have been slowly adding to our position in this company and our intention is to collect its dividends for decades.
With that, thanks for reading and listening to this edition of Special Situation Investing. As always, we enjoy the increasing interactions we are having with you all and are appreciative of all your support. Your shares, likes and comments encourage us that you find our work worth your time. Since time is the most precious resource, that means the world to us. Thank you.
Portfolio Update (NRP & MSB)