A Closer Look at the Fourth-Quarter Results From Vanguard Natural Resources LLC

Distribution coverage ratio falls, but the company has a plan to get it back where it needs to be.

Feb 27, 2014 at 1:00PM

Wyoming Drilling

Photo credit: Flickr/Wendy Shattil/Bob Rozinksi-International League of Conservation Photographers

Oil and gas MLP Vanguard Natural Resources (NASDAQ:VNR) reported its fourth-quarter and full-year results after the market closed yesterday. While the company reported net income of $10.9 million or $0.14 per unit, those aren't the numbers that really matter for investors. So, let's dig into the more important figures.

A closer look at the numbers that matter
For investors in Vanguard Natural Resources the most important number is the company's distributable cash flow, which clocked in at $42.7 million, or $0.55 per unit. That represented an increase of more than a million dollars from last year's fourth quarter. But on a per-unit basis it represents a significant drop from the $0.70 per unit in distributable cash flow the company earned in last year's fourth quarter.

One of the reasons for the drop in distributable cash flow per unit is the simple fact that the company has more units outstanding this year. That's in addition to the fact that the distribution has increased over the past year. Those two factors, when combined with lower realized low prices for gas and oil, caused the company's distribution coverage ratio to drop to 0.88 times from the 1.15 times the company reported in last year's fourth quarter.

That drop in the coverage ratio does raise a red flag, especially the fact that it's now below the critical 1.0 times level. But according to the company the drop is temporary. This year Vanguard Natural Resources is guiding for a coverage ratio that is 1.12 times at the midpoint of its guidance. Its recent acquisition of natural-gas assets in Wyoming is expected to fuel the boost in cash flow that will enable it to hit or exceed that number.

A closer look at production
For the fourth quarter the company produced an average of 36,903 barrels of oil equivalent per day, or BOE/d. That's a substantial boost from the 22,803 BOE/d the company produced in last year's fourth quarter. Virtually all of that production growth was a result of acquisitions over the past year.

Looking ahead Vanguard Natural Resources expects production to surge again in 2014. A big reason for this is the aforementioned natural-gas acquisition, which will include the company's participation in the drilling of natural-gas wells as a nonoperated partner with Ultra Petroleum (NYSE:UPL) and QEP Resources (NYSE:QEP). These two factors led Vanguard Natural Resources to project that its production will grow to a range of 51,888-55,217 BOE/d in 2014.

There's a big difference in how Vanguard Natural Resources and its partners plan to spend growth capital in 2014. Vanguard Natural Resources anticipates minimal spending for organic growth as its plan calls for $22.5 million to be spent on growth, which is a small slice of its total capital spend of $136.5 million. Ultra Petroleum, on the other hand, is planning to spend about a half billion dollars in 2014 with more of its spending earmarked toward growth. Overall, 77% of its 2014 capital budget will be spent on drilling for natural gas in the Rockies, including wells in Wyoming. That's really no surprise as 71% of the company's production comes from the region. Meanwhile, QEP Resources has a $1.8 billion capital plan in 2014. But it is only planning to spend 15% of its 2014 capital budget to grow its natural-gas production in the region, simply because QEP Resources has oil-rich-drilling opportunities in the Bakken Shale.

Investor takeaway
Vanguard's switch to investing to grow its natural-gas production organically is something investors need to watch. While its spending nowhere near the capital of Ultra Petroleum or QEP Resources, this is a big shift for the company. In addition to that investors need to watch the distribution coverage ratio, which slipped below 1.0 times for the first time all year. As it stands now, the company's recent acquisition has that ratio rising well above that number in 2014, so there doesn't appear to be any reason for investor to worry. For now, that keeps the company's distribution on solid ground.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends Ultra Petroleum. The Motley Fool has the following options: long January 2016 $25 calls on Ultra Petroleum. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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