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A Beaten-Down MLP with a Rising Payout

By Ari Charney on February 1, 2013

Although we cover the entire master limited partnership (MLP) space, when it comes to actual investment recommendations, we focus our coverage on midstream MLPs that derive a majority of their income from fee-based contracts. That means they get paid based on the volume of energy products they store or transport, so they’re only indirectly exposed to volatile commodity prices.

Nevertheless, one of the exploration and production MLPs that went public last year could offer an intriguing opportunity. Atlas Resource Partners LP (NYSE: ARP) is currently rated “hold” in the MLP Profits “How They Rate” table and has a safety rating of “0.” And its units are down a little more than 27 percent from their 52-week high.

However, thanks to rising production following a series of acquisitions last year, management has raised its 2013 distribution guidance to a cumulative payout of $2.35 to $2.50 per unit. Even at the low end of that range, the resulting yield is over 10 percent at current unit prices.

The MLP just boosted its latest quarterly distribution to $0.48 per unit, an 11.6 percent rise from the prior quarter and a 20 percent jump from its first full quarterly payout. Its distributable cash flow (DCF) increased about 30 percent sequentially to $18.5 million, which was sufficient for a coverage ratio of 1.1.

Shortly after the MLP was spun off from Atlas Energy LP (NYSE: ATLS), our initial take was that its outsized exposure to natural gas would pose a significant headwind over the next few years, as the abundance of natural gas supply continues to weigh on prices.

We also noted that its general partner’s (GP) incentive distribution rights entitle it to an increasing percentage of the distribution as it grows over time. And based on management’s targeted payout range, the distribution could hit the threshold otherwise known as the “high splits” some time later this year. Once the quarterly payout reaches $0.60 per unit, the GP will receive 48 percent of the incremental cash available for distribution above and beyond that point.

That may sound esoteric, but what it means in practice is that it’s difficult for common unitholders to enjoy further distribution growth once the payout rises above that level. But depressed unit prices and the prospect of a 10 percent-plus yield may make such considerations largely academic.

But what about the MLP’s sizable exposure to natural gas? After all, such high yields aren’t all that meaningful if they can’t be sustained. ARP owns an interest in over 10,100 oil and natural gas producing wells in key shale plays situated in Texas and Appalachia. And after last year’s acquisition activity, natural gas comprised an even larger share of ARP’s mix of production revenue during the third quarter than it did during the prior year.

Natural gas accounted for almost 81 percent of the MLP’s $24.7 million in production revenue during the third quarter, as compared to roughly 9 percent for oil and just over 10 percent for natural gas liquids (NGL).

To mitigate the risk from the vagaries of energy commodity prices, ARP has an aggressive hedging program. For instance, the MLP has already hedged 90 percent of its 2013 natural gas production at an average price of $3.89 per thousand cubic feet, which is about 5 percent higher than analysts’ consensus forecast for the average price of natural gas this year.

Meanwhile, management is further diversifying the MLP’s production mix via acquisitions. In late December, ARP closed on a deal to acquire proved reserves of 35 million barrels of oil equivalent (MMboe) in the Barnett Shale and Marble Falls near Ft. Worth, Texas. The former DTE Energy Co (NYSE: DTE) assets have estimated proved reserves of 24 percent oil, 33 percent NGLs, and 43 percent natural gas. 

While gas and oil production account for about one third of ARP’s overall revenue, the MLP also has an investment partnership business where it raises capital for its own drilling activities in concert with third parties. These investment partnerships are a key source of fee-based revenue, which provides some stability relative to its income from production. Because ARP shares the investment with these other entities, it earns ongoing fees from administration and oversight, well services, and gathering.

While well construction accounts for 48.6 percent of overall revenue, the latter three fee-based services account for 18.2 percent of revenue.

ARP’s near-term prospects may remain closely tied to natural gas, but future acquisitions could eventually change that. In the meantime, its fee-based revenue and rising production from acquisitions should support the distribution in the near to medium term.

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  1. avatar
    Rohrshack Reply February 2, 2013 at 9:13 AM EST

    Do you have a long position in ARP?