During this past week’s joint monthly web chat for subscribers of The Energy Strategist and MLP Profits, we received several questions about Vanguard Natural Resources (Nasdaq: VNR). So let’s get to know this energy income play a little better.

 Vanguard Natural Resources is structured as a publicly traded limited liability company with partnership tax status. VNR is not technically a master limited partnership or a corporation. In fact, its investor FAQ notes as much, but then in investor presentations they will refer to themselves as an MLP. VNR does issue K-1 forms typical of an MLP and from an investor’s point of view functions just like an MLP. Much of the distribution is tax-deferred as with an MLP, but VNR does not have a general partner or incentive distribution rights.

VNR is one of 14 companies/partnerships that are categorized as exploration and production, or “upstream.” Other notable entries in this category include BreitBurn Energy Partners (Nasdaq: BBEP), Linn Energy (Nasdaq: LINE), Memorial Production Partners (Nasdaq: MEMP), QR Energy (NYSE: QRE), Legacy Reserves (Nasdaq: LGCY), EV Energy Partners (Nasdaq: EVEP), and Mid-Con Energy Partners (Nasdaq: MCEP).

Most of VNR’s proved reserves — ~300 million barrels of oil equivalent (MMBoe), or ~1.8 trillion cubic feet equivalent (Tcfe) — is natural gas (66 percent), and 60 percent of its reserves are producing. In 2013 production was 35,400 Boe/d, and current proved reserves would last more than 23 years at that production rate.  

VNR’s production is concentrated in the mid-continent region of the US. Reserves are located in the Arkoma Basin in Arkansas and Oklahoma, the Permian Basin in West Texas and New Mexico, the Big Horn Basin in Wyoming and Montana, the Piceance Basin in Colorado, South Texas, the Williston Basin in North Dakota and Montana, the Wind River and Powder River Basins in Wyoming, and Mississippi.


Source: Vanguard Natural Resources (Stars denote VNR major producing fields.)

VNR had its initial public offering (IPO) in October 2007, and has since made 20 strategic acquisitions totaling some $3.4 billion. These acquisitions have supported 48 percent distribution growth since 2008. The company has adopted a disciplined acquisition strategy targeting mature oil and gas properties with specific characteristics. VNR seeks acquisitions that will have a long and stable production life with a shallow decline. The company looks for reserves in which a high percentage are producing, but with opportunities for additional growth.

Unlike most midstream MLPs, upstream partnerships have direct commodity exposure that can threaten  their distributions if commodity prices soften. VNR limits that risk through active commodity and interest rate hedging. It has approximately 80 percent of expected oil production hedged through 2015 at a floor price of $93.07 per barrel, and approximately 80 percent of expected gas production hedged through 2017 at $4.42 per million British thermal units (MMBtu). This makes for more consistent and predictable distributions.

In July 2012 VNR became the first MLP to institute a monthly cash distribution policy. The current monthly distribution of $0.21 per unit ($2.52 annualized) yields 8.4 percent at the current price. While VNR’s distribution has grown by 48 percent since its 2007 IPO, the yield currently trails its upstream peers:

Source: VNR investor presentation

Over the past five years, the upstream MLP group has made strong gains, but most of those took place from 2009 through 2011. Over the past three years, the group as a whole has made little headway:

In 2012 VNR began a strategic shift towards natural gas properties. It has since completed five primarily natural gas acquisitions. Management believes, as I do, that natural gas is undervalued, and by acquiring these natural gas assets while prices were low it hopes to deliver significant long-term upside for unitholders

In January the company closed on an acquisition in the Pinedale field in southwestern Wyoming. It was VNR’s largest investment to date in natural gas and the second-largest transaction in its history. The Pinedale reserves are approximately 45 percent proved developed and 55 percent undeveloped. At the closing, the Pinedale acquisition increased Vanguard’s reserves and production by approximately 80 percent and 55 percent, respectively.

At its current price of $30.01 per unit, VNR has an enterprise value (EV) of $3.35 billion and an EV/EBITDA ratio of 11.9. In the fourth quarter of 2013 distributable cash flow (DCF) totaled $43 million or $0.55 per common unit, which resulted in a Q4 coverage ratio of 0.89. For the full year, DCF totalled $185 million for a coverage ratio of 1.0.

For those wishing to add an upstream MLP to their portfolio, VNR is one of the less risky and reasonably priced options. My colleague Igor Greenwald provides more in-depth coverage of VNR in MLP Profits, including specific price targets.

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Portfolio Update

MLPs Flash Cash at Record Highs

The recent market weakness has entirely bypassed MLPs, with the Alerian MLP Index closing at a record high Monday in celebration of rising energy prices, steady interest rates and the continuing boom in domestic crude production. Still, the index is up a modest 5 percent over the last year, so that even after adding the indicative 6 percent yield MLPs trail the 17 percent 12-month total return of the S&P 500.

Meanwhile, two portfolio holdings that have risen 24 percent over the last year before distributions recently hiked their payouts yet again. Top-ranked Best Buy Enterprise Products Partners (NYSE: EPD) announced a 6 percent year-over-year increase in the first-quarter distribution. It will pay 71 cents per common unit on May 7 to holders of record as of April 30, for a current yield of 3.9 percent. This is a continuation of the recent trend that has seen Enterprise retain a good chunk of its distributable cash flow to finance a profusion of growth projects. Buy EPD below $75.

Genesis Energy (NYSE: GEL) raised its distribution 10.6 percent year-over-year, extending its track record of double-digit growth. It will pay 55 cents per common unit on May 15 to holders of record as of May 1. At that level, the prospective yield is 4 percent. The crude logistics partnership has experienced some operational hiccups of late, thinning its distribution coverage. GEL remains a Hold.                     

— Igor Greenwald