A High-Yielding Oil Producer With Accelerating Distribution Growth

In the world of investing I love three things above all else: a high yet secure yield, dividend/distribution growth, and a monthly payout. The following company offers investors all three in one tidy package.

Vanguard Natural Resources (NASDAQ: VNR  ) is an oil and gas producing Limited Liability Corporation (LLC) that pays out distributions to unit holders. Among high-yield seeking income investors it is known for three things:

  • A generous 8.4% yield
  • Strong distribution growth of 48.2% growth over seven years which is equivalent to a 5.78% compound annual growth rate
  • A monthly payout -- which is great for paying living expenses or for compounding faster through distribution reinvestment

Vanguard is a fast-growing E&P (exploration and production) company with daily production growing by 93.4% from 18,300 Mboe/d (thousands of barrels of oil equivalent/day) in 2012 to 35,400 Mboe/d in 2013.

The key to the company's fast growth and high-yield has been its strong track record of successful accretive acquisitions (acquisitions that immediately raise cash flow enough to increase distributions). Since Vanguard went public in 2007 it has made 20 accretive acquisitions totaling $3.4 billion. The most recent acquisition is also the company's largest and offers long-term investors the greatest opportunity. 

On Dec 23, 2013, Vanguard purchased natural gas fields in Wyoming for $581 million. The estimated reserves include 847 billion cubic feet (bcf) of natural gas and increased the company's reserves by 80%. Current production from these fields is 113.4 million cubic feet/day (mmcfe/d), which raises Vanguard's daily production by 50%. The company has announced a $136 million investment program to increase this production further. This represents just one of three catalysts that will drive stronger growth, both for the company and the distribution. 

Catalysts for growth

  • Vanguard is projecting large increases in production in 2014.
  • Total production is projected to increase by 46%-56% from 35,400 mboe/d to 51,830 mboe/d-55,220 mboe/d.
  • Oil production projected to increase from 8,462 bpd to 8,800-9,400 (4%-11% increase).
  • Natural gas liquids, (such as Butane) increasing from 4,047 bpd to 7,200-7,650 bpd (78%-88% increase).
  • Natural gas production to increase from 136,632 mcf/day to 215,000-229,000 mcf/day (58%-67% increase).

Another catalyst is Vanguard's excellent use of hedging.

According to CFO Richard Robert, "On a total basis, our natural gas is hedged 85% in 2014, 92% in 2015, 85% in 2016, and 47% in 2017 all at weighted average prices of about $4.42." 

"In terms of oil, 2014 expected oil production is 93% hedged, 2015 is 64% and 2016 is 24% hedged, all at a weighted average price of approximately $92.71 per barrel." 

According to the 2013 10-K, Vanguard's average sale price for natural gas and oil was respectively $3.39/mbtu and $82.26/barrel. The new hedges represent a 30% and 12.7% increase in prices Vanguard will receive in the future. 

The recent fracking boom in Texas resulted in a glut of oil at the terminal in Cushing, Oklahoma (where WTI is priced). This resulted in low oil prices that Vanguard locked in via long-term hedges to ensure future cash flows. Today, increased pipeline construction is decreasing that oil glut, and WTI prices are rising to $101.58/barrel. This sharp increase in WTI is hurting refiners such as HollyFrontiers, Valero Energy, Phillips 66, and Marathon Petroleum (who are seeing their margins compressed severely which will hurt their profitability going forward). However, for oil producers such as Vanguard this increase in WTI is not just good it is great. 

As Vanguard's existing hedges (which lock in the price they get for its oil) expire, the company will purchase new hedges locking in the much higher current WTI price. This will ensure that even if oil production surges and WTI prices decrease, Vanguard will receive higher prices for the oil it's producing at an accelerating rate. 

The final catalyst that will drive Vanguard's growth is its decreasing production costs. According to the company's 10-K, in 2011 production costs per barrel of oil equivalent were $13.07. This declined to $11.1 in 2012 and fell to $8.15 in 2013. Management is guiding for 2014 extraction costs to drop to $6-$7.

Due to these three catalysts management is guiding for 2014 EBITDA of $415 million which is a 30% increase over 2013. With capital expenditure (capex) rising by $57 million, this would mean $48 million in additional distributable cash flow ($0.69/unit). 

This would increase the distribution coverage ratio from 1 in 2013 to 1.24 in 2014 and allow management plenty of room to raise the distribution.

Bottom line
In summary, Vanguard's management has an excellent track record in accretive acquisitions and is sure to continue adding additional resources to the company's portfolio. This will result in increasing production. Falling extraction costs and rising prices on Vanguard's hedged production will ensure accelerating and consistent revenue growth and a fast growing distribution. Thus, Vanguard Natural Resources represents the trifecta of investing: high-yield, accelerating distribution growth, and capital appreciation. I would advise every income investor to consider whether Vanguard deserves a spot in his/her income portfolio. 

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  • Report this Comment On March 31, 2014, at 12:39 PM, clnauert6 wrote:

    So if history stays true it is about time someone questioned their bookkeeping methods. This should begin an SEC investigation because too many people are being helped with dividends and us retirees are making too much money.

  • Report this Comment On March 31, 2014, at 2:58 PM, AdamGalas wrote:

    Technically retires are being richly compensated through distributions, but we can quibble over such details as we clink flutes oh champaign and dine on the finest caviar:)

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