When investors see their holding nearly cut in half, it's a pretty obvious sign that the underlying company has issues that need to be addressed. In the case of Vanguard Natural Resources, LLC (NASDAQ:VNR), which was down 48.6% last year, it had three areas of weakness that turned out to be bigger problems than the company's management team expected. Those issues need to be addressed if the company has any hopes of turning things around in 2015.
No. 1 issue to address: Distribution
One of the reasons the value of Vanguard Natural Resources' units was cut in half last year was that investors worry that the company's distribution is at risk of being reduced. Management is well aware of this, which is why its top goal for 2015 is to ensure the safety of its payout, as we see in the slide below.
That said, the company's CFO, Richard Robert, recently told the Wall Street Journal that it might still need to cut the payout. He noted that the payout cuts of two of the company's peers were "prudent" moves. Furthermore, he said that a distribution cut might "ultimately be the prudent thing for us to do, at least you sleep a little better at night." So, clearly, the company needs to address its distribution and either confirm that it will hold the line this year or reset the rate so investors know what to expect.
No. 2 issue to address: Balance sheet
Vanguard Natural Resources also noted on that slide that its second goal this year is to reduce its leverage. Its balance sheet is a growing concern since the plunge in oil prices has the potential to weaken the company's credit metrics, as its EBITDA will weaken due to its cash flow from oil production slipping in 2015. Because of this, the company needs to either bump up its EBITDA some other way or pay down debt.
One of the ways it's planning on reducing leverage is by issuing equity to buy assets from private sellers this year. In using equity, the company can tip the scale a little bit to the equity side of the balance sheet, but at the same time it will add to its EBITDA. It's a move that could make a lot of sense if it can find the right deals.
No. 3 issue to address: Long-term hedging strategy
The main reason the company's distribution is at risk and its balance sheet is weakening is that the company's oil and gas cash flows are going to be falling over the next year due to the surprising plunge in oil prices. Vanguard Natural Resources does hedge a large portion of its oil and gas production to mute this impact, which we can see on the slide below.
However, these hedges aren't enough when the industry goes through a real rough patch like the one it's experiencing at the moment. Because of this, the company needs to seriously reconsider how much of its production it protects in the future as well as the duration of that protection. In obvious hindsight, no less than 100% oil and gas hedges for two to three years would have been adequate to endure the current downturn unscathed. Because of that, the company needs to seriously consider whether that is the direction it needs to head in, or else it needs to better communicate to investors that its distribution might be a fixed rate, but that that fixed rate can be substantially reduced when oil and gas prices go into a tailspin.
Vanguard Natural Resources has its work cut out for it in 2015. The company needs to make a decision on its distribution and work to bolster its balance sheet. On top of that, the company really needs to address its hedging policy going forward, as its current policy leaves it open to way too much downside, as was evident by the nearly 50% haircut investors took last year.
Matt DiLallo has no position in any stocks mentioned, which is a good thing because the oil downturn has really cut into his dividend income this year. 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.