Over the past few years, coal prices have plummeted. The global recession caused companies to cut back on production, which meant they needed less power from coal. In addition, the world is slowly shifting to alternative sources of energy like wind, solar, and natural gas. For a small-cap coal company like Rhino Resource Partners (NYSE: RNO), this has not been welcome news. This company’s revenues and share price both fell sharply along with the price of coal. Rhino’s share price is down about 50 percent since 2011.
Given the way things are going, should investors give up on Rhino? Not necessarily. Coal may be down, but it’s far from out. While coal might seem like the energy source of the past, it is still incredibly important for world energy production. Coal produces about 40 percent of world energy. China is especially reliant on coal and is both the largest producer and importer of this resource. As the world economy continues to recover, countries will need more energy. We are still nowhere near completely replacing coal as a resource so more energy demand means higher coal prices. Rhino’s share price would see a nice boost when this eventually happens.
In the meantime, Rhino is paying its investors to wait with a sizable dividend. This company currently has a healthy dividend yield of about 13 percent. Rhino can afford this decent payout because it is running at a solid 11.5 percent profit margin. When falling coal prices reduced Rhino’s revenues, the company was able to respond by reducing its costs. A key reason why Rhino is so flexible with expenses is because a major part of Rhino’s business is to lease coal properties; it doesn’t primarily make its money from mining. This means that Rhino doesn’t have to pay for a permanent mining workforce or for the cost of operating mines. Coal mining companies like Alpha Natural Resources (NYSE: ANR) and Arch Coal Inc. (NYSE: ACI) don’t have this option and have been bleeding money over the past few years.
The question is how long can Rhino afford to keep paying high dividends? As long as it keeps its profit margins up, Rhino should be able to keep paying some money to investors. What’s a little troubling is that this company doesn’t have much of a buffer should things start to go wrong. Rhino has almost no cash in reserve and also holds a fair amount of debt; the company has a 53 percent debt/equity ratio. To hedge against risk, it might be a good idea to hold several companies using the same strategy as Rhino, paying a high dividend while waiting for coal prices to go up. Oxford Resource Partners (NYSE: OXF) and Natural Resources Partners (NYSE: NRP) are also suitable choices.
In the short-run, Rhino is paying out a decent income. Long-run, this stock depends on the price of coal. If prices stay low, Rhino will be in trouble. However, if prices climb back up, Rhino would turn out to be a great investment. Considering the way the world, especially China, is growing, I would bet on the latter outcome.