Atlas Resource Partners, L.P. (NYSE: ARP) is a relative newcomer to the monthly payout party, having announced the switch earlier this year. However, since making its first monthly payout in March, the company has already boosted the payout, as its growth strategy is delivering tangible results. With that increase, investors can lock in an annual yield of more than 15% thanks to the company's currently beaten down unit price. However, before we salivate too much over that yield, let's drill down a bit deeper to make sure this juicy payout is sustainable.
Atlas Resource Partners 101
For investors not familiar with the company, Atlas Resource Partners is an upstream master limited partnership, or MLP. Upstream simply refers to the fact that the company owns and operates oil and gas wells, as opposed to the pipelines and processing plants owned by a more typical midstream MLP. Currently, the company owns 13,000 producing oil and gas wells that are spread around the country as we see on the following map.
Source: Atlas Resource Partners, L.P. Investor Presentation.
Atlas Resource Partners' production and reserves are pretty heavily weighted toward natural gas. Currently, about 90% of its production is natural gas, while 83% of its reserves are gas.
The other important aspect investors need to know about Atlas Resource Partners is that not all of its money is made from oil and gas production. The company also operates a partnership drilling program where it raises money from qualified investors to drill wells on their behalf, earning Atlas fee-based revenue for managing the wells. About 17% of the company's gross margin comes from partnership fees, which helps to support the company's strong monthly payout.
Drilling down into the monthly payout
Atlas Resource Partners pays out $2.36 per unit on an annual basis. However, through the first six months of this year, the company has paid out nearly $5 million more to investors than it earned in distributable cash flow, which equates to a 0.95x coverage ratio, or a shortfall of about 5%. That's a bit of a warning sign, as that ratio should be 1.0x at a minimum, and ideally 1.10x to provide a bit of a margin for error. That being said, Atlas Resource Partners is in the process of integrating a number of acquisitions that will improve its distributable cash flow and coverage ratio in future quarters.
However, those assets might not provide as much boost as the company had planned, due to the severe sell-off in oil prices during the past few months. While Atlas Resource Partners does hedge a large portion of its exposure to commodity prices, about 19% of the company's total gross margin is left unhedged as we see in the following slide.
Source: Atlas Resource Partners, L.P. Investor Presentation.
Given that its distribution coverage ratio is borderline, at best, this is a pretty big risk, as tumbling oil and gas prices could weaken its coverage ratio further. The plunge in oil prices could be an unforseen risk here given that its last two acquisitions were of oil-weighted assets. Overall, the large unhedged volumes leave Atlas's monthly payout at greater risk of being cut than some of its better-hedged competitors.
Atlas Resource Partners currently provides one of the highest monthly income streams in the upstream MLP sector. However, with that high payout comes a bit more risk, as the payout ratio is weaker than we'd like to see, and its strength is questionable as Atlas' hedging practices aren't as strong as some of its other peers. That might be a risk worth taking as energy prices could spike higher; but energy prices could keep going lower, which could force the company to cut its currently all-too-generous payout.
