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Memorial Production Partners (NASDAQ: MEMP ) is one of a number of upstream MLPs that have entered the public markets over the last few years. Like most MLPs, Memorial provides a high distribution yield, and its most important profit metric is not earnings per share but distributable cash flow. Spun off by its parent company in 2012, Memorial is still a young partnership, and was set up to receive assets dropped down from its parent company, Memorial Resource Development. Also, like its parent company, Memorial (the partnership) is primarily a producer of natural gas.
Right now Memorial's valuation is among the lowest and its distribution among the highest of its peers. It is for this reason that Memorial deserves a closer look. Upon this closer look, I believe there is a lot to like about this partnership.
Most investors buy into MLPs for the income, and so a partnership's securing of cash flow from production is an important factor. Memorial's hedging policy is one of the most conservative and extensive in the business. Eighty percent of both gas and oil production for 2014 is already locked in. Even better, a majority of Memorial's gas production is hedged through 2019. And best of all, these hedges either come at low cost or no cost because they are either "collars" or "swaps," with limitations on both the downside and upside. When compared to its upstream MLP peers, Memorial's hedging is more extensive than all big names other than Linn Energy (NASDAQ: LINE ) , which hedges 100% of its production. This gives investors peace of mind that the distribution will be secure.
Rising distributable cash flow coverage
Management estimates that distributable cash flow, or DCF, will rise to at least $158 million this year versus $130 million from last year, thanks largely to the partnership's accretive acquisitions in 2013. This hike in DCF will lead to better coverage for the existing distribution. In 2013, DCF is expected to be at least 1.1 times distributions. In 2014 the coverage ratio will tick up to at least 1.15 times. This makes Memorial one of the more well-covered partnerships in this space. When considering not only higher coverage but also an extensive hedging policy, Memorial's 10% distribution yield is quite secure.
An inventory of assets
Based on 2014 production rates, Memorial also has about 16 years worth of production just from its existing assets. But we can be reasonably sure that Memorial will continue to acquire because its parent company, Memorial Resource Development, has 500,000 gross acres and an additional 1 trillion cfe in reserves, 70% of which is natural gas. Some of this acreage, perhaps a lot, will be dropped down to the partnership at some point. Memorial should be able to continue producing, like it is now, for two decades. That is a conservative estimate.
Valuation and bottom line
For a couple of reasons, earnings per share is neither useful nor relevant in valuing an upstream MLP. Because of this, most instead use DCF to value these names. Based on Memorial's 2014 guidance, Memorial currently trades at 8.4 times DCF, making Memorial the cheapest among its peers. Memorial's 10%+ yield is also higher than that of any peers.
Right now there is a lot to like about Memorial. The partnership has a deep, high-margin asset base. Memorial's hedging policy is fairly extensive. Finally, the partnership's distribution coverage is improving, making that 10%+ yield a secure one.
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