Oil Pump With Red Moon

Image source: Getty Images.

While the oil market downturn has had a profound impact on the sector in general, it has brutalized upstream MLPs. For evidence, we just need to look at a chart of Vanguard Natural Resources' (NASDAQ:VNR) unit price over the past two years:

VNR Chart

VNR data by YCharts

That said, while that performance is atrocious, the company has at least been able to avoid the fate of two of its largest upstream MLP rivals, which have already filed for bankruptcy. It is a fate Vanguard would like to avoid. To do so, it needs to show improvement in three metrics when it reports results this week.

1. Has it done anything to address its liquidity issues?

Vanguard's biggest problem at the moment is its concerning credit metrics. In particular, the company borrowed $1.414 billion under its revolving credit facility, which became a grave concern after its banks cut its borrowing base down to $1.325 billion in May. As a result of that reduction, the company has to repay the $103.5 million deficiency in six equal monthly installments of $17.3 million. Thankfully, it has roughly $40 million in cash, which when combined with the cash flow provided by its robust oil and gas hedges puts the company in the position to make these payments.

That said, the company is really living on the edge right now and needs to do something to address its liquidity concerns. One option it should pursue is additional asset sales, with its position in the Permian Basin the best opportunity. Thanks to the basin's compelling drilling economics at current prices, producers are paying top dollar for assets in the play. For example, earlier this month Permian-focused drillers Diamondback Energy (NASDAQ:FANG) and Laredo Petroleum (NYSE:LPI) announced transactions to boost their acreage positions in the play. Diamondback Energy spent a whopping $560 million to acquire more than 19,000 acres consisting of 1,000 barrels of oil equivalent per day (BOE/d) of production. Meanwhile, Laredo Petroleum invested $125 million in the acquisition of 9,200 net acres and 300 BOE/d of associated production. Just for perspective, Vanguard Natural Resources produces about 9,800 BOE/d out of the Permian, implying that its assets could hold significant value if sold to other drillers.

2. Did it complete any additional debt reduction?

In addition to borrowing heavily on its credit facility, Vanguard Natural Resources also had more than $600 million in senior notes outstanding to start the year. However, after undertaking a second lien exchange in February, the company was able to acquire $168 million in its legacy bonds for $76 million in new second-lien notes. That move not only chipped away at its debt load but reduced its annual interest expense by $7.9 million.

Given the discount its senior notes are trading at in the open market, it would make sense for the company to consider actions to take out additional notes. Because of that, look to see if any further exchanges are in the works or if it used some of its cash to repurchase debt during the quarter.

3. Was it opportunistic to increase its 2017 hedges?

One of the reasons Vanguard has been able to generate excess cash flow this year is that it has strong oil and gas hedges in place. However, as the slide below shows, those hedges are significantly weaker next year, especially on the oil side:

Vanguard Natural Resources Hedging

Source: Vanguard Natural Resources Investor Presentation.

That is a potential problem for the company because if oil prices plunge again, it could see a significant drop in cash flow next year. To prevent that from happening the company needs to add additional hedges as it has done in the past during times when prices shift to the upside, which is just what happened last quarter after oil and gas rallied 37% and 56%, respectively. We have already seen other producers take advantage of that rally with Laredo Petroleum, for example, adding hedges in July to cover more than 2 million barrels of oil production in 2017. Ideally, Vanguard will have joined its peers to take advantage of the recent rally to bulk up on its hedges. 

Investor takeaway

Vanguard Natural Resources has a razor thin margin for error right now. That is why it needs to be proactive to address its issues to prevent them from becoming a grave problem should oil and gas prices take another tumble. If it does not act now, it might be too late to do so later, which is what its rivals discovered earlier this year leaving them with no choice but to file for bankruptcy.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.