Oxford Resource Partners, LP (OXF)

[Tommy]

$OXF - Oxford Resource Partners Offers Multi-Bagger Potential Despite Its Problems

http://seekingalpha.com/article/1583202-oxford-resource-partners-offers-multi-bagger-potential-despite-its-problems?source=email_stocks_and_sectors&ifp=0

Editor's notes: A recent debt refinancing leaves OXF free to execute on a turnaround plan. As coal reaches a positive inflection point, shares could have 50-150% upside.
Alpha-Rich articles are our best money-making long and short investment ideas.

Oxford Resource Partners (OXF), the company, is not a 'gem' in the natural resource group - by far. With flat revenue, losses, a high debt load, and its limited partner unit prices near all-time lows, it is nowhere on the radar of the momentum crowd - at least, not yet. Heck, it will show up at the bottom of even the most popular value screens. But through over 20 years of investment management experience, I have learned that the most loved companies are not always the best stocks to buy, and often even vice versa. The value of a stock should be measured only in terms of the return it can offer, and often the most rewarding opportunities are found in the most unlikely places - among unloved, underfollowed, and un-cool stocks; and it is even better when these stocks have a recent or upcoming catalyst(s) that has been ignored by the market.

At a market-cap of $45 million, OXF is a thinly-traded unknown micro-cap, in a world of much larger peers in the coal industry group. The recent refinancing of its credit facilities, and the impact it has in terms of removing bankruptcy risk, improving liquidity and increasing financial flexibility, has gone largely unnoticed. Its units are still trading as if the company was going bankrupt. As we will demonstrate later, modeling this reduction in bankruptcy risk leads us to a valuation of over $6 for its units, well above current prices in the $2.20's.

OXF's operations are turning around, and the company faces a positive outlook both in terms of improved production outlook at its mines in Northern Appalachia as well as the projected 2.79% annual growth rate in U.S. coal pricing, based on the latest forecast from the U.S. Energy Information Administration (EIA). This positive outlook does not seem to have been modeled into the projections of the 2-3 analysts that cover the company. As we will demonstrate later, modeling this into a discounted cash flow analysis, along with other positives from the company's recent conference call, leads us to a much higher intrinsic value for the units, in the $3.20-$5.50 range. Also, a comparison to its coal industry peers based on EV/EBITDA leads us to a much higher valuation for the units, at over 200% above current levels.

The improvement in its operations will be evident in its earnings reports, with the next one scheduled for about a week from now, on August 7th. The projected improvement in revenue, gross margins and operating income, from its future earnings reports, will shine a light on OXF, transforming investor perception of it from being a troubled company to one that is an attractive turnaround value play in the coal industry, and thereby help bring the market valuation of its units more in line with its intrinsic value.

Company Overview

Columbia, OH-based Oxford Resource Partners is a low-cost producer of high-value steam coal in Northern Appalachia and the Illinois Basin. It went public on July 14th, 2010, on the NYSE, with lead underwriters Barclays (BCS) and Citigroup (C) offering 8.75 million common units representing Limited Partner Interests (LPIs) at $18.50 per unit. Prior to that, Oxford Mining Company, formed in 1985, remained a private company for over 20 years, and became a partnership in August 2007.

OXF has 19 active surface mines in the region, and is also the largest producer of surface mined coal in Ohio. All of its mines are strategically located within 45 miles from a major means of transportation, and OXF also operates two river terminals in Ohio and Kentucky. This enables it to efficiently serve large electric coal-fired, base-load scrubbed power plants located in Illinois, Indiana, Kentucky, Ohio, Pennsylvania and West Virginia, under long-term sales contracts (see location map below).

OXF Mining Locations & Market Area Footprint (click to enlarge) Source: Company Website

OXF owns and/or controls 86.4 million tons of proven and probable coal reserves, of which 62.1 million tons are associated with its surface mining operations and the remaining 24.3 million tons consist of underground coal reserves that they have subleased to a third party in exchange for a royalty. The company has been good at replacing its reserves, acquiring 7.2 million tons of proven and probable coal reserves in 2012, an amount greater than the 6.8 million tons produced during the year. Of the 6.8 million tons, the lion's share, 5.8 million tons were produced at its 17 mines in Northern Appalachia, while the remaining 1.0 million tons were produced at its two remaining mines in the Illinois Basin.

The 17 active surface mines in Northern Appalachia are grouped in seven mining complexes, the largest of which, the Cadiz mining complex located in Jefferson County, Ohio, accounts for 1.9 million tons of production and has over 8.4 million tons of proven and probable reserves. The next two large mining complexes include Belmont County in Ohio, with 1.0 million tons of production and over 13.0 million tons of proven and probable reserves, and the New Lexington mining complex, located in Perry, Athens and Morgan counties in Ohio, with 0.8 million tons of production and 3.7 million tons of proven and probable reserves. The remaining four mining complexes in Northern Appalachia together produce 2.1 million tons of coal, and have over 17.6 million tons in proven and probable reserves (see Chart).

(click to enlarge)

The company has subleased to a third party the underground coal reserves at the Tusky mining complex in exchange for an overriding royalty. The Tusky mining complex has 24.3 million tons of proven and probable reserves, and generated $1.5 million in royalty in 2012. Also, the company has scheduled for the two mines at the Illinois Basin complex to be idled by 4Q/2013. The Illinois Basin complex produced 1.0 million tons in 2012, and has 19.4 million tons of proven and probable reserves. OXF has redeployed some of the Illinois Basin equipment to its Northern Appalachia mines, and is seeking to sell the excess equipment.

OXF's customers are regional electric utilities, located near the mining complexes. Its three largest customers together account for almost three-quarters of its revenues, with those being American Electric Power Company (AEP) (34.5%), FirstEnergy Corp. (FE) (23.0%) and East Kentucky Power Corp. (15.1%). Its top ten customers together account for 93.3% of total coal revenues. Most of the purchasing by electric utilities is done under long-term contracts of one year or longer, thereby providing OXF with greater predictability of sales volume and prices. For Q1/2013, OXF sold 95.5% of the coal tons under long-term supply contracts, and the remainder through short-term contracts and on the spot market. As of the end of Q1/2013, substantially all of OXF's projected sales for the balance of 2013 has been committed and priced, and for 2014, 2015 and 2016, OXF has committed tons under the terms of the supply contracts for 5.2 million, 4.4 million and 2.5 million tons of coal, respectively.

OXF's primary competitors in the intensely competitive coal industry include Alliance Resource Partners LP (ARLP), Cloud Peak Energy (CLD), Hallador Energy Company (HNRG), James River Coal Co. (JRCC), Natural Resource Partners (NRP), Walter Energy (WLT), Westmoreland Coal Co. (WLB), and other smaller, independent companies. Being a commodity, the most important factor on which they compete is price, along with coal quality and characteristics, transportation costs, and the reliability of supply. But for the most part, many of these are outside their control, as coal consumption and pricing depend on electricity consumption patterns, which are dependent on economic activity and weather patterns, and also the price of coal in comparison to competing fuel sources, including natural gas, renewable and nuclear energy. Other factors influencing coal demand and pricing include government regulation, that has generally been a negative influence lately, and technological developments, especially in terms of the development of clean coal that helps mitigate carbon dioxide and other greenhouse gas emissions from the burning of thermal coal for electricity generation.

Coal Industry May Be At An Inflection Point

While the market keeps making new highs, coal stocks as represented by the Market Vectors Coal ETF (KOL) keep marking new lows. The industry is almost universally hated, and has been engulfed by a perfect storm lately. Environmental concerns have been exaggerated by a hostile political environment that has increased regulatory costs, while tough competition from falling natural gas prices has lowered its share as an energy source. The share of renewable energy sources is also rising, while global demand growth is being hampered by weak economic conditions globally, particularly in Europe, and a slowdown in China.

However, many of these adverse conditions are beginning to turn around. Natural gas generation is down 15% year-to-date, while prices are up from the $2/MMBtu bottom in early 2012 to $3.73/MMBtu at yesterday's close. As natural gas prices rise, coal is becoming cost-competitive again, and the reverse switch by electric utilities from natural gas to coal has already started. In Q1/2013, U.S. domestic coal demand by the power sector rose 3%, while overall U.S. coal consumption rose 10%. Furthermore, the U.S. Energy Information Administration forecasts that coal's share of electricity generation in the U.S. will rise from 37.6% in 2012 to 39.0% in 2013 and 39.6% in 2014. We believe that a coal pricing recovery is at hand, and we should also see a better contracting year in 2013. Coal prices should follow the rise in natural gas prices (see Chart), and along with the increase in coal demand from the reverse natural gas to coal switch, it should lead to a recovery in the prices of many coal stocks.

(click to enlarge)

U.S. coal prices were down 2.9% in the first quarter of 2013 compared to the same quarter a year ago, while the average sales price realized by OXF during the same period was up from $49.02 to $50.65. The long-term trend for U.S. coal prices is expected to be bullish, with the U.S. Energy Information Administration projecting an average 2.79% annual growth rate from $2.45 / Million BTU's in 2012 to $5.28 / Million BTU's by 2040. This translates to almost $110 per short ton of coal by 2040, a more than two-fold rise from current prices in the $50 range.

(click to enlarge)

Environmental concerns notwithstanding, coal is here to stay, as it is the only global energy source that has the scale and cost advantage to meet growing global energy needs. Coal companies provide much of the fuel that is used for electricity production in the U.S., accounting for the largest share, at 38% of U.S. power production. This is almost as much as natural gas and renewable sources combined, which account for 30% and 12% of electricity generation respectively (see Chart). Nuclear power accounts for most of the remainder, at 19%. Globally, coal accounts for an even higher 41% of electricity generation. Furthermore, the U.S. has abundant coal resources available with 237 billion short tons of proved recoverable coal reserves, accounting for 22.6% of the global reserves. This makes it the 'Saudi Arabia of Coal,' given that Saudi Arabia accounts for a similar 20.0% of global oil reserves.

(click to enlarge)

An Even Better Production Outlook for Northern Appalachia Coal

The outlook for coal production in OXF's primary Northern Appalachian region is extremely promising, with production estimated to increase at a 1.10% annual rate between 2010-2040, while overall U.S. coal production is estimated to rise at only a 0.2% annual rate during that period. The difference in growth rates is even more striking in the short term, as in the four-year period from 2012-2016, coal production in Northern Appalachia is expected to rise at a 4.6% annual rate, while overall U.S. coal production declines at an annual rate of 1.0% (see Figure 2). Coal production in the neighboring Central Appalachian region is expected to decline precipitously from 186 million tons in 2010 to 87 million tons by 2040, with part of the deficit filled up by increasing production forecast for the Northern Appalachian coal mines, including the 17 surface mines operated by OXF.

(click to enlarge)

OXF Operations are Improving

In its latest March quarter, announced on May 15th, OXF reported a 28c loss, missing analyst consensus estimates, but almost at par with the 29c loss reported in the year ago March quarter. Revenues came in-line at $88.70 million v/s $88.65 million estimates, but were down 9.4% year-over-year. The results were adversely impacted by a termination notice received in Q1/2012 from a customer related to a 0.8 million tons per year coal supply contract fulfilled from their Illinois Basin mining operations. In response, the company has decided to idle its Illinois Basin operations, which is expected to result in total impairment and restructuring expenses of $17.2 million, including $15.7 million recognized in FY 2012. This included asset impairment costs of $12.7 million, severance and other termination costs of $1.9 million, professional and legal fees cost of $1.0 million, equipment relocation costs of $0.9 million, and coal lease termination costs of $0.7 million. As a result, OXF units are down about 70% in the past year, trading near all-time lows (see chart).

(click to enlarge)

Source: bigcharts.marketwatch.com

Despite the doom and gloom, however, operations seem to be improving. OXF exceeded production goals and beat its production targets for the quarter. Adjusted EBITDA improved over $2 million sequentially, to $9.0 million from $6.8 million in the prior quarter. Cash margin per ton increased 7.9% to $6.40 from $5.93 in the prior year March quarter, despite the challenging coal market, driven by a 3.2% increase in coal sales revenue per ton to $50.68, partially offset by a 2.7% increase in cash costs to coal sales per ton to $44.25. Also, its sales book is 98 percent committed and priced for 2013, based on currently anticipated levels of production, and it is 79% committed for 2014, with 47% of that priced. Also, recent declines in utility stockpiles and higher natural gas prices in the northern Appalachian and Illinois Basin are encouraging, as they should lead to an increase in customer demand and improved pricing. When that happens, the company has the ability to increase its production by up to 10% with little incremental cost.

In the March quarter report, the company also raised its projection for the June quarter sales to 6.0-6.5 million tons of coal from the previously provided range of 5.8-6.3 million tons. They also expect an improvement in the selling price per ton to $50.50-$52.50, with an anticipated average per ton cost of $42.85-$44.85, so cash margin per ton is expected to rise to the $7-$8 range. Also, the company projected that adjusted EBITDA will continue to improve, rising to $45-$50 million for FY 2013, which means that the next three quarters will generate about $13 million per quarter. The company is scheduled to release its Q2 earnings report on August 7th before the market opens.

Bankruptcy Risk Removed

On June 25th, Oxford closed on $175 million of new credit facilities that replaced both its previous term loan and revolving credit facility, thereby extending the maturity of the Partnership's debt and increasing availability under its revolver. The new credit facilities secured by substantially all of the assets of the Partnership and its wholly owned subsidiaries, consist of two liens of $75 million each, and a $25 million revolving credit facility. By extending the maturity profile of its debt and increasing availability under its revolver, Oxford has significantly enhanced its liquidity as it continues to focus on increasing productivity across its operations, and participating in a coal market rebound. OXF indicated that the new credit facilities would be used to retire both the existing term loan maturing in July 2014 and the existing revolving credit facility that matured this month. The first $75 million lien matures in August 2015, with an optional extension to May 2016, and the second $75 million lien matures in December 2015, with an optional extension to September 2016. The covenants under the new credit facilities specifically preclude the Partnership from making any unit-holder distributions during the term of the new facilities.

This refinancing was a big deal as it required negotiation and resolution with ten individual lenders, and at the time of its Q1/2013 earnings report, OXF only had $5.3 million in cash with no available borrowing capacity on its revolving credit facility that matured in July. Also, as of June 18, 2013, it had $147.5 million in borrowings outstanding under the facility, including $104 million under the revolver and $43.5 million under the term loan, and also an additional $10.9 million in letters of credit outstanding under the Credit Agreement. While OXF was current on all of its principal and interest payments, it was in default of certain financial covenants. Hence, all of its borrowings outstanding under the credit facility were presented as a current liability in the Q1/2013 report. With the resolution of the financing, this debt now becomes a long-term liability, as it is not incurred within one year.

The removal of the bankruptcy risk, however, has gone largely unnoticed, due to OXF being an unknown, micro-cap company in an out-of-favor industry group. Zack's Equity Research currently ranks the coal industry 247th out of 261 industries, and the average coal stock as represented by the Market Vector Coal ETF is down 65% from its highs two years ago. The resolution puts OXF on a solid financial footing, boosting liquidity and improving financial flexibility, so that it can position itself for a rebound in the coal market demand and pricing. However, the units are still trading at the same levels as when the credit facilities' refinance was announced on June 25th. We believe that value-oriented long-term investors can take advantage of the mispricing resulting from the market not factoring in this reduction in bankruptcy risk.

Estimating Fair Value After Removal of Bankruptcy Risk

The Z-score, developed by NYU Asst. Professor Edward I. Altman in 1968, is a widely used tool to predict corporate defaults and to measure the financial distress of companies. The Z-score uses multiple corporate income and balance sheet values, including working capital, profitability, debt levels and liquidity (see equation below).

(click to enlarge)

Source: Wikipedia

In the table below, we calculate the Z-score for OXF at the end of each quarter, for the last eleven quarters since the company came public, and also the current Z-score after the refinancing of the credit facilities. The main change that raises the Z-score from 0.80 at the end of Q1/2013 to 1.55 currently is the reduction in current liabilities due to the credit facilities refinancing. The current 1.55 Z-score is similar to the Z-score the company had before the revolving credit facility become a current liability after Q2/2012. The units have fallen off precipitously since that time, corresponding with increased bankruptcy risk as the maturity date for its debt and revolver got closer, and it started violating some of its financial covenants.

(click to enlarge)

In the table, we also calculate the Enterprise Value / EBITDA or EV/ EBITDA for each of those quarters. We like EV/ EBITDA in preference to P/E as it is capital-structure neutral, and therefore can be used to directly compare companies with different levels of leverage in the same industry.

As can be seen from the table, the EV/ EBITDA was much higher in the 6 to 10 range, when the Z-score was in the 1.5-1.6 range prior to Q3/2012. Using the lower value of the range, given the current weakness in the coal industry, we then arrive at a fair Enterprise Value of $282 million. Backing out the total debt and minority interest, and adding back cash and short-term investments, we arrive at a fair market value for the units at $128 million or $6.16 per unit, at almost three times the current unit price.

We then cross-checked this by also calculating the current EV/EBITDA for OXF and four of its closest coal industry peers, including Alliance Holdings (AHGP), Cloud Peak Energy, Hallador Energy, Natural Resource Partners, and Westmoreland Coal, all of whom are primarily involved in the mining of thermal coal in the U.S. Applying the average EV/ EBITDA for its five peers to the company's projection of $47.5 million in EBITDA, we arrive at a fair value per unit of $4.87-$7.63, more than twice above OXF's current unit price.

(click to enlarge)

Intrinsic Value Calculation

Intrinsic value, often used by value investors, refers to the actual value of the shares or units of a company as determined using fundamental analysis. This is in contrast to calculating the value based on a comparables analysis of various financial ratios, such as P/E and EV/EBITDA, for the company versus its closest peers in the industry. While there are many ways at arriving at an intrinsic value for a stock, qualitative and quantitative, we focus here on the discounted cash flow (DCF), the most popular method used by security analysts. Basically, it involves projecting a firm's operations into the future, and calculating the net present value (NPV) of all of its expected future net cash flows, including assigning a terminal value at the end of the forecast period (see table below).

(click to enlarge)

The assumptions used in the above model are derived based on:

the company's conference call for Q1/2013, in which they discussed projected revenue and costs for FY 2013, including Capital Expenditures
the 30-year forecasts by U.S. Energy Information Administration for production of Northern Appalachian Coal and thermal coal pricing
gross margin improvement projected based on long-term trend for OXF and its peers (see chart below).
SG&A and Capital Expenditures were generally assumed to rise in proportion to sales growth, except for FY 2013, based on statements by company in its Q1/2013 conference call.

(click to enlarge)

The company's weighted average cost of capital (WACC) was calculated to be 11.3%, with assumptions as illustrated in the table below.

Based on the above, we arrived at a NPV of $73.9 for the FCFs for ten years out up to 2022.

The terminal value is very sensitive to the assumption on long-term growth rate, so we modeled three scenarios. The first one is a base case, where we assumed the long-term revenue growth rate as 3.9%, based on the long-term 2.8% annual production growth for Appalachian coal and the long-term 1.1% annual price growth for thermal coal, as forecast by the U.S. EIA. Based on that, we calculated the Enterprise Value for the base case for OXF to be $222 million. Backing out the total debt and minority interest, and adding back cash and short-term investments, we arrive at a fair market value for the units at $67 million or $3.21 per unit, almost 50% above current levels.

We assumed the high-growth scenario to have a revenue growth rate equal to 5.6%, equal to the annual growth rate calculated based on U.S. EIA forecast for the year 2022. The assumption here is that either coal prices would keep rising at a stronger rate than forecast by the U.S. EIA or that the company would replace reserves and increase production at a faster rate than that projected for Northern Appalachian coal by the U.S. EIA. The resulting Enterprise Value calculated for this high-growth scenario was $269, which calculates to a fair price per OXF unit of $5.54. Then, we also modeled a medium-growth scenario of 4.5% annual revenue growth, which resulted in a fair value per unit of $3.90.

The Catalyst

It was declining revenue, gross margins and operating income, and the threat of bankruptcy that led to the precipitous fall in OXF units to the $2.20s, from the $18.50 IPO offer price in July 2010, and the $28.80 all-time high in February 2011. The re-financing of the company's credit facilities on June 25th has already removed the risk of bankruptcy. However, refinancing news is fairly esoteric and difficult for most investors to put a value on, and other than an upgrade on June 26th by Wells Fargo, including raising its price target to $2.70-$3.80 from $2.00-$2.40, the market has largely ignored the news.

The reporting of OXF's Q2 earnings report in about a week, on August 7th, will most likely remove the second factor thwarting its units from being valued higher by the market. Based on the company's own statements in its Q1 conference call, on coal sales volume and operating expense projections, and the coal pricing forecast by U.S. EIA, we project that the company will report higher revenue, gross margins and operating income for Q2, and even higher projections for Q3 and FY 2013 (see charts).

(click to enlarge)

(click to enlarge)

The turnaround in operations will be evident as both revenue and operating income will be trending up for the first time in over two years. The last time that happened, OXF was trading in the mid-to-high teens. Also, revenue and operating income levels are approaching the levels when it traded in the mid-to-high teens, and debt levels are only slightly higher. Even backing out the additional debt, we arrive at valuations in the teens. This new trend of rising revenue, gross margins and operating income will be hard to ignore, and will get better with every successive quarter, for the short term. Also, starting with the Q3 report, the company will also start revealing its outlook for FY 2014, which based on our projections (explained earlier) will reveal even further operational improvements. The positive quarter-over-quarter comparisons will shine a light on the company, and change investor perception of it from being a troubled company to a turnaround value play in the coal industry. It is conceivable that at some point, either with the Q2 or Q3 earnings report, this may also lead to some sorely needed new analyst coverage of the units, which given their current depressed valuation is bound to be positive, bringing it more in line with the intrinsic value of its units.

Additional Catalysts That Could Mean Even More Upside

Our financial models assume a moderate improvement in the coal industry, as forecast by the U.S. EIA. While that is entirely reasonable, given that coal is a cyclical industry, it is also entirely possible that the perfect storm that has made coal stocks among the most undesirable may completely reverse, not just improve. This may include a change in Administration in 2017 to possibly a Republican controlled White House, Senate and House of Representatives, driving down regulatory costs for the coal industry, and paving the way for the development of more coal mines and production in the U.S. Natural gas prices may rise again, far higher than forecast by the U.S. EIA, aided by a strong recovery in the world economy, thereby increasing the demand and price for coal far more than what is projected in our financial models.

With the strong cash flow projected for the future, along with the company aggressively working towards improving its cost structure, it is very likely that the company at some point in the next three to five years will reinstate its dividend, pay down its debt, acquire additional reserves, or any combination of these. OXF before it discontinued its dividend in 4Q/2012 had among the highest trailing dividend yields in the coal industry, paying 20c in the 3Q/2012, and 44c per quarter prior to that. The reinstatement of the dividend should have an even greater positive impact on the unit price than that projected in our models.

Units Upgraded by Analyst

On 26th of June 2013, a day after OXF refinanced its credit facilities, Wells Fargo upgraded the units to Market Perform from Underperform, raising its price target to $2.70-$3.80 from $2.00-$2.40, citing the removal of bankruptcy risk with the company's debt refinancing and inexpensive valuation at 4.4 times FY 2014 EBITDA.

Risks to Thesis

We believe that coal stocks in general, and OXF in particular, have already factored in most of the potential negatives into their current stock price, and there is very little downside from here. But among the negatives, the Obama administration in its last term could impose even more stringent regulatory requirements on the coal industry. This appears unlikely, though, based on his recent climate change speech on June 25th, in which he reiterated some of the same rhetoric we have heard earlier on limiting the use of 'dirty energy' and using more 'clean energy,' but nothing new in terms of actual legislative actions. Another negative scenario is that the coal industry could continue to straddle at the bottom, and OXF could face the same bankruptcy scenario in three years.

The lowest OXF units traded, even in mid to late-June when the company was in violation of certain financial covenants and faced imminent bankruptcy risk, as it negotiated for a resolution of the credit facilities with ten individual lenders, was $2.10. Given that the company has now eliminated that bankruptcy risk and is no longer in violation of financial covenants, with the maturity of the debt having been extended to 2015/16, it is unlikely that even if operations don't improve as projected by the company and the U.S. EIA, that it would break those levels. Furthermore, technically it has been confirming a bottom in the $2.10 range, hitting it three to four times in the last five months, and each time rising immediately to the $3 range and above.

Additionally, based on our DCF model, perpetual annual revenue growth in the out-years would have to drop to 2.4% for the fair valuation of the units to be below $2. This is unlikely given that coal, a cyclical commodity, is trading near its lows, and at 60% below its recent highs from 2008, and also given that Northern Appalachia coal demand and thermal coal pricing are projected by the U.S. EIA to have long-term annual growth rates of 2.8% and 1.1% respectively. Also, the company's coal mining assets are almost all located in the high-growth Northern Appalachia region, where production is expected to rise at a 4.6% annual rate in the short term, from 2012-2016, and at 1.10% long term. This compares well with both overall coal production in the U.S., that is expected to decline at an annual rate of 1.0% in 2012-16 and rise at 0.2% annual growth long term, as well as the neighboring Central Appalachia region, that is projected to see production fall from 186 million tons in 2010 to 87 million tons by 2040. Given that, we believe that at below $2, the present value of OXF's projected cash flows, particularly given its presence in the attractive high-growth Northern Appalachia market, would be attractive for a strategic buyer, from among its peers operating in the region.

Conclusion

OXF has been a massive underperformer since its IPO three years ago, down 88% from its offering price of $18.50 per unit, and trading near all-time lows. It operates as an unknown micro-cap in the coal industry that is deeply out-of-favor with investors. Added to this, it has a high debt load, that until recently was pushing the company towards bankruptcy. However, as is often the case in value investing, this negative sentiment towards the coal industry, and OXF in particular, has created a 'gem' of an opportunity for the patient, long-term, discerning value investor. Although one analyst upgraded and raised his target on the units to up to $3.80, the market has largely ignored the refinancing of the company's credit facilities last month. As we demonstrated, the removal of the bankruptcy threat alone translates to a significantly higher price for OXF right now, in the $6 range, well above the current price in the $2.20's. Also, we arrive at a much higher intrinsic value for its units, between $3.21-$5.54, by discounting its future cash flows to the present.

Clearly, OXF's fundamentals are not attractive right now, at least when looking at the sales and earnings for the last twelve months. The company, however, has painted a picture of improving operations and a recovery in EBITDA going forward. Furthermore, forecasts of Northern Appalachian coal production and overall thermal coal pricing by the U.S. EIA paint an even more promising picture for OXF for the long term. The coal industry could be on the cusp of the start of another 'super-cycle,' aided by rising overseas energy demands and a recovering global economy. Although none of these are certain, we believe the worst is already priced in, and it will be hard for a strategic buyer to resist acquiring OXF's coal mining assets in the high-growth Northern Appalachia region if unit prices fall significantly below $2. Also, technically, the units have found support in the $2 range, and have been bottoming there for the last few months. The upside, however, is significant, with us arriving at target prices at least 50% above current levels, and maybe as much as 200% higher, based on an analysis of its intrinsic value (bottom-up analysis), based on comparables to its peers in the industry, and an analysis of the removal of bankruptcy risk based on the Altman Z-Score.

With upside potential of 100% or more, and a downside risk in the 10% range, we believe that an investment in OXF is a no-brainer. Sure, value investing sometimes requires confidence and a leap of faith, even a contrarian mind-set, buying something and waiting for the market to take notice. But most legendary investors have made their money practicing value investing principles. In closing, we believe it is apt to mention one of Warren Buffett's famous quotes, "Be fearful when others are greedy and greedy when other are fearful."

Business Relationship Disclosure: The article has been written by the Hedge and Mutual Fund Analyst at GuruFundPicks.com. GuruFundPicks.com is not receiving compensation for it (other than from Seeking Alpha). GuruFundPicks.com has no business relationship with any company whose stock is mentioned in this article.