Market Doubts Memorial Production Partners LP Will Fulfill 10% Distribution Yield

Shares of Memorial Production Partners (NASDAQ: MEMP  ) , an upstream master limited partnership, or MLP, engaged in production of oil, gas, and natural gas liquids in some of the country's oldest, lowest-decline, and highest-margin hydrocarbon fields, dropped by over 5% last Wednesday on the release of the company's quarterly earnings. Memorial's distributable cash flow came in at a frightening 0.70 times distributions, falling well short of both expectations and the minimum coverage at which distributions can be paid. Also, today's earnings call came on the heels of an announcement of Memorial's largest acquisition ever. This article will evaluate Memorial's results, its distributable cash flow coverage, and finally its most recent acquisition. 

New equipment in a very old field. Bairoil, Wyoming. Source: geology.ohiostate.edu

A tough first quarter
There is no doubt that Memorial's distribution coverage came up well short this quarter. However, before investors panic, they must first consider a few things. First and foremost, the first quarter of any North American exploration and production company, especially those operating in the mid-continent like Memorial does, is almost always the weakest. That's because winter weather often leads to forced downtime. This winter was much colder than most, and so Memorial's production, along with that of many others, was hurt. The EBITDA impact on Memorial's Permian curtailments was between $5 million and $7 million, which is quite big considering that Memorial's total EBITDA this quarter was only $55 million.

Second, Memorial faced an issue with a natural gas plant in South Texas, which was offline and unable to receive natural gas liquids production for a good period of time. Other South Texas NGL producers, such as Rosetta Resources (NASDAQ: ROSE  ) , suffered from similar circumstances. 

However, management explicitly said that it still planned on hitting its distributable cash flow, or DCF, guidance of between 1.1 and 1.2 times distributions. Memorial still has one of the highest coverage ratios in the upstream MLP industry. Sure, the partnership has quite a hurdle to jump, but I believe management deserves the benefit of the doubt here. 

Apparently the market doesn't agree. 

Bairoil acquisition
This quarter's results come right on the heels of a gigantic $931 million acquisition of oil-producing acreage in southern Wyoming. 

Courtesy of Investor Relations

As you can see, the 'Bairoil' acquisition completes Memorial's transformation from a dry gas producer to a diversified producer of dry gas, natural gas liquids, and crude oil. The Bairoil acquisition is also consistent with Memorial's mission to secure mature, low-decline, and high-margin production. For example, the Bairoil acreage is expected to continue producing oil for at least the next 39 years. At only 7.5 times EBITDA, this acquisition is immediately accretive to DCF. 

Discovered way back in the early 1900s, the Bairoil fields are still operative today thanks to an enhanced oil recovery technique called CO2-flooding. Oil fields using CO2-flooding often have margins far higher than that of other prevailing techniques such as shale drilling or deepwater drilling, simply because the oil recovered by CO2-flooding is found at a much shallower depth. This is an important acquisition for Memorial.

Bottom line
Memorial undoubtedly has a lot of catching up to do if it wants to hit its lofty guidance goal for the year. With yesterday's drop, Memorial once again yields over 10%. I believe that is a bankable yield at a very reasonable price. However, Memorial will also likely issue equity at some point to finance its big, recent acquisition. You may yet get Memorial at a better price, but nevertheless I believe that it is a good value right here. 

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