This Bullish Engulfing Candle Says Buy This Coal MLP: NRP

Relieved traders surely noticed the sharp rally in the S&P 500 this week. The rally occurred just when it seemed the overall market was headed much lower because of a break of support at the key 1100 to 1120 zone in the S&P.

What is less known is this formation was termed by Richard Wycoff, a famous technical analyst and teacher, as a "spring" formation. A spring occurs when a stock breaks a key horizontal support level and then quickly rallies back into the support zone. The spring is often the springboard to a rally that lasts several weeks and takes prices much higher.

In conjunction with the bullish action in the overall market, many individual stocks showed impressive turnarounds. One I'm particularly attracted to is master-limited partnership (MLP) coal producer and marketer, National Resource Partners (NYSE: NRP).

In the chart below, you'll notice NRP weekly bullish engulfing candle (the large white body wraps around or engulfs the previous red body). This candle is often a technical signal of an important reversal in trend. While I want to trade cautiously in this very volatile market, this may be an opportunity to buy NRP, a company with extremely solid fundamentals, trading at bargain basement prices.

As the fifth-largest owner and leaser of coal reserves in the United States, NRP controls more than 2 billion tons of coal reserves in 11 U.S. states.

The company leases its reserves in exchange for royalty payments. Because the company leases rather than operates its properties, it has limited operating expenses. As a result, it sports a robust current annual yield of about 8.4%. This yield should support the share price even if you don't stick around long enough to collect many dividend payments.

Metallurgical coal (met coal) accounts for about 33% of NRP's production and nearly 40% of its coal royalty revenues. In fact, 25% of all met coal in the United States comes from NRP properties. Metallurgical coal is used in steel-making. The company also has thermal coal reserves, used to generate electricity.

Chairman and CEO of Peabody Energy, Gregory Boyce, believes we are "in the early stages of a long-term super cycle for coal." In the past decade, coal was one the world's fastest-growing fuel sources. With Asian nations building coal-fired power plants, this trend should continue. What it means in the near-term, is that there should be support for coal prices.

Furthermore, recent merger and acquisition (M&A) activity among coal companies -- such as the joint bid between ArcelorMittal (NYSE: MT) and Peabody Energy (NYSE: BTU) for Australian coal producer Macarthur Coal, as well as the buyout offer for Walter Energy (NYSE: WLT) -- creates a bullish undertone for coal shares.

From a technical perspective, NRP shares currently appear to be near an attractive entry point.

The stock is down roughly more than 20% from its July 2011 high of $34.43, but appears to be on the cusp of breaking its intermediate-term downtrend line, formed off the July high.

For much of 2010, shares were on a strong uptrend, rising from a low of $16.48 in May 2010 to a high of $35.56 by March 2011.

Encountering strong resistance in a zone around $34-$36, shares gradually dropped to support near $23. During the Oct 3rd trading week, the stock jumped off $23 support and looks poised to retest a shelf of resistance near $28.

If the stock can break $28 resistance, then it could bullishly break out of a descending triangle pattern. Shares could then retest the $36 level. From my buy-on-stop level of $28.03, this would represent more than a 30% gain.

From a fundamental perspective, NRP is very solid.

For the first half of the 2011 year, the company reported record revenue, as a result of high coal prices -- especially met coal -- and higher coal production at its Central Appalachian properties. For the six months ending June 2011, revenue increased 23% to $176.2 million, from the year-ago period.

Due to the growing demand for metallurgical coal by developing nations such as China and India, the company expects record level of met coal exports for the full 2011 year. NRP also anticipates met coal prices will stay about $300 per metric ton, well above 2010 prices. As a result, analysts estimate full-year 2011 revenue is likely to expand 15.5% to $348.1 million, from $301.4 million last year.

By 2012, analysts project revenue will likely increase a further 10% to $383.4 million.

With MLPs, the key financial measure is not earnings, but rather distributable cash flow. Distributable cash flow is a figure based on earnings that also adds back expenses such as depreciation and depletion.

For the first half of 2011, distributable cash flow increased 115% to $83.9 million, from $38.9 million. The rise was due to strong revenues and improvements in working capital.

With growing coal royalty revenue, distributable cash flow should continue to rise throughout the full 2011 and 2012 years.

In 2010 and, so far, for 2011, the company's quarterly distributions have remained unchanged at $0.54, for an annual yield of about 8.4%.

Because NRP has a solid fundamental outlook and looks to be at a technically attractive entry point, I plan to go long on the MLP, if it can breaks $28 resistance.

Risks: If there is a sharp slowdown in China or other Asian countries, coal demand will drop and the MLP will likely suffer. That said, Chinese gross domestic product growth is expected to remain close to 9%, which should underlie robust coal demand.

Given overall market volatility, I will, however, enter the position with caution, placing a buy-on-stop order at $28.03, just above the resistance level. This means I will only enter the trade if the stock reaches $28.03 or above.

My stop-loss will be $23.63, just below a shelf of support. My target is $36.56, the stock's recent high. The risk/reward ratio is roughly 1.94:1.