On Wednesday, units of Vanguard Natural Resources (NASDAQ: VNR ) , an upstream LLC engaged primarily in dry-gas production, dropped by almost 3% in the wake of its quarterly earnings report. This article will look at Vanguard's drop in price and offer a bigger-picture view of Vanguard with the new information we have.
Long story short, Vanguard dropped yesterday because the expected distribution-coverage ratio for the quarter fell well short of expectations. Management expected distributable cash flow, or DCF, to be 1 times distributions, but instead DCF came in at only 0.8 times. This is a big deal because most investors in Vanguard own units primarily for the distribution income. Adding to this is the fact that Vanguard finished 2013 with an overall coverage ratio of only 1 times DCF, leaving no margin for error.
From the looks of things right now, the shortfall looks to be due to a convergence of factors, all of which seem to be just delays and timing issues. Management itemized the DCF shortfall for the quarter, which came out to $8 million.
- Half of the shortfall can be attributed to delays in the drilling of recently acquired Pinedale dry-gas acreage in Wyoming, in which Vanguard is not an operator. The issue here is that the two operators, QEP Resources (NYSE: QEP ) and Ultra Petroleum (NYSE: UPL ) , have experienced delays in drilling 'non-consent' wells unrelated to Vanguard's working interest. As a result of these issues, QEP and Ultra have been delayed in the drilling of wells in which Vanguard does have a working interest. This is apparently 'just a delay.' In addition to this, unusually cold weather on the partnership's Arkoma acreage delayed drilling and curtailed production there.
- The other half of this shortfall came from higher capital expenditures in the Pinedale. Since Vanguard is not the operating partner here, management does not have final say as to when wells will be drilled and capital will be spent. QEP and Ultra elected to spend large portions of their respective full-year capital budgets in the first quarter. While this was clearly something Vanguard didn't expect, it will not change the overall capital budget for the year.
In fact, management still expects 2014 DCF coverage to come in at 1.1 times for the year.
Tough learning curve
At $580 million, the Pinedale deal represents Vanguard's largest acquisition ever. It also represents a change in direction for the partnership.
Vanguard previously was a cash flow-centric partnership, focusing only on well-developed gas fields which required minimal drilling. This attribute consistently gave Vanguard the lowest capex/earnings before interest, taxes, depreciation, and amortization ratio among upstream master limited partnerships. It also allowed for a simpler prospectus: Instead of having to delineate 'growth' capex from 'maintenance' capex like most other upstream MLPs do, Vanguard simply reported capital expenditures as a whole.
Pinedale may change that. The Pinedale acquisition gives Vanguard about 10 years worth of growth drilling inventory. Since drilling for growth isn't management's specialty, some of these timing mishaps, such as for capital expenditures from operating entities and the unforeseen delay in wells in which Vanguard has an operating interest, could be expected. Remember, Vanguard only closed this deal in February, and management may need some time to sort things out.
As of right now, I think Vanguard still deserves the benefit of the doubt, especially because management affirmed its full-year DCF guidance. Does that make the units a buy right here? I still don't think so. In addition, Vanguard's unit price has increased steadily between the latter part of 2013 and today, while several other upstream MLPs have gone nowhere.
Finally, Vanguard's yield of 8.2%, while impressive, is actually lower than many other upstream MLPs with similar or better coverage ratios. Before either buying or selling, I think it's best to wait this one out.
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