DBRS Confirms Penn Virginia Resource Partners at BBB (low)

DBRS notes that the rating for Penn Virginia Resource Partners, L.P. (PVR or the Company) remains on track at BBB (low) with a Stable trend. Notwithstanding its recent diversification into natural gas midstream operations, the rating continues to be underpinned by the Company’s core business of managing and leasing coal properties.

PVR’s properties are leased out to numerous coal operators. Royalty payments by the lessees provide a steady revenue stream and cash flow fundamentals. The lessees are responsible for all the operating, transportation, capex and personnel costs (including posting environmental bonds at the leased properties). Accordingly, the principal business risk retained by PVR comprises the matching of operators to its properties such that production and hence royalty revenue is maximized. The Company has a strong track record in this area, with a minimal occurrence of lease disruptions.

PVR’s coal properties are primarily located in Central Appalachia (CAPP). CAPP coal commands higher pricing due to its combination of high energy output and low sulphur content. However, the region has been subject to extensive long-term mining that has degraded the reserve base and, along with labour shortages, increased production costs. In 2005, PVR expanded the geographic scope of its coal properties through the acquisition of 94 million tons of reserves in the Illinois Basin (and has since increased that total to 133 million tons as of year-end 2006.) While coal sourced from the Illinois Basin is presently priced at a discount due to its high sulphur content, this should moderate in the medium term with the planned rollout of emission-reducing scrubbers in the United States.

In March 2005, PVR’s business profile was also diversified through the $199 million acquisition of natural gas midstream assets in Oklahoma and Texas (the Cantera acquisition). To control the commodity risk associated with this type of business, PVR applies a variety of contracts as well as an active hedging program to cover between 50% and 60% of its annual exposure.

In 2005, the natural gas midstream segment generated approximately 20% of total operating profit, this figure increasing to 29% in 2006. Going forward, PVR will pursue growth in both business segments on an opportunistic basis, with potential expansion projects being evaluated on rate-of-return criteria as opposed to a targeted strategic allocation between the coal and natural gas midstream businesses.

In pursuing further expansion through acquisitions, the Company incurs integration risk. PVR also assumes some operational risk through its foray into the natural gas midstream business.

PVR has historically funded its growth with a combination of debt and equity proceeds. While leverage (gross debt-to-total capital) increased to 47% as of year-end 2005, this has been reduced to 35% as of year-end 2006, primarily through the issuance of $115 million in new equity in December 2006. Management has a conservative leverage policy and has demonstrated discipline in this regard through repeated equity offerings.

It is this financial discipline, combined with the Company’s steady revenue streams, that further bolsters the rating. Should the Company demonstrate further progress in its expansion activities while adhering to its current financial policy, DBRS would consider an upgrade.

Note:
All figures are in U.S. dollars unless otherwise noted.