Legacy Reserves has transitioned from an upstream master limited partnership (MLP) to a C-Corp, which is the most commonly used structure for tax purposes. The company made this change due to the significant damage caused by the oil market downturn on upstream MLPs, which are those that produce oil and gas as opposed to owning pipelines or other midstream assets. In the last three years, 11 of the 13 former upstream MLPs filed for bankruptcy or transitioned away from the upstream sector. Legacy was able to navigate through the downturn without declaring bankruptcy by completing a series of transactions that reduced debt and brought in funding so that it could stay afloat. Those initiatives allowed it to survive so that it could transition into a traditional oil and gas producer.
The company's new corporate structure will give it the flexibility so that it can focus on developing its drillable land in the lucrative Permian Basin. Legacy holds a sizable acreage position in the region that contains an estimated 673 net drilling locations. The company plans to develop those wells with cash flow generated by its legacy oil and gas business in the Permian, Rockies, and East Texas.
While Legacy Reserves has come a long way over the last few years, the company remains very risky since it still has an elevated debt level. As of the end of the second quarter, its debt-to-adjusted EBITDA ratio was 4.7 times, which, while well below the peak of 7.6 times in 2016, is much higher than the sub-2.0 comfort level of most oil-producing peers. The company hopes to drive that number down as its Permian production grows and oil prices continue improving. However, with $543 million outstanding on a credit facility that matures next year, an unexpected drop in oil prices could significantly impact the company's ability to operate. That's why investors might want to consider buying one of these top oil stocks instead.