Image source: BP via flickr.com.
Earlier this week, Vanguard Natural Resources (NASDAQ: VNR) reported a very mixed mag of results. Its net loss of $468 million might sound shocking at first, but like so many other producers today, there is a lot that went into that number. More importantly, though, the company was able to generate more cash than anticipated. Let's break down the rather complex earning numbers at Vanguard this past quarter and take a look at what could be in store in the future.
By the numbers
| Results (in Millions, Except Per-Share Data) | Q3 2015 | Q3 2014 | % Change |
|---|---|---|---|
| Revenue | $155.1 | $236.9 | (34.5%) |
| Adjusted EBITDA | $88.2 | $108.2 | (18.2%) |
| Net Income Attributable to Unitholders | ($468.9) | $109.1 | -- |
| Distributable Cash Flow | $31.2 | $52.9 | (40.9%) |
| Distribution Coverage Ratio | 1.02 | 1.00 | -- |
Data source: Vanguard Natural Resources earnings release.
If you are quick to do math in your head, it's pretty easy to see there is a lot going on behind the scenes in those figures, so let's unpack them a bit. Adjusted EBITDA declined less than revenue as compared to last year because the company realized a benefit by monetizing some of its 2018 and 2019 hedges it inherited in the recent acquisitions of LRE Energy and Eagle Rock Energy Partners.
Net income plunged deep into the red this quarter because the company took a $491 million impairment to its asset values. Luckily for investors, this is a non-cash expense that has little bearing on its cash flow.
Of all these numbers, though, individual investors should focus on distributable cash flow and distribution coverage ratio. This quarter, the company's cash coverage was just slightly above its payout. It's not a great number, but let's put the number in perspective. Management expected the coverage ratio to come in below 1.0 times for the quarter, but its capital expenditures came in lower than expected. Another thing to consider is that its payout hasn't been cut as drastically as its peers without needing to stretch itself too thin to meet the payout.
| Company | % Distribution Cut (LTM) | Distribution Coverage Ratio (Q3 2015) |
|---|---|---|
| Vanguard Natural Resources | 50% | 1.02x |
| Breitburn Energy Partners (BBEPQ) | 76% | 1.9x |
| LINN Energy (LINEQ) | 100% | N/A (distribution suspended |
Data source: Company earnings and press releases.
Another promising sign now that the LRE Energy and Eagle Rock Energy Partners acquisitions have closed is the increased production and improved hedging positions should boost its coverage ratio. Management projects that in the fourth quarter, its coverage ratio will be in the 1.4 times range. If it can meet that target, then it should put a lot of investors worries to bed at least for a few quarters.
How low can you go?
Vanguard, like Linn, Breiburn, and every other oil producer out there, are price takers when it comes to oil & gas. No one has the leverage to dictate prices, so the best these companies can do is control costs as best as possible to eke out what small profits are available today. For Vanguard and other upstream MLPs that have protected prices into the future, there is the nagging worry that those hedges will roll off before we see a significant uptick in price.
Of the three companies here, Vanguard has the least amount of hedging coverage for its production portfolio over the next couple years:
| % of Production Hedged | 2016 | 2017 | 2018 | 2019 |
|---|---|---|---|---|
| Vanguard Natural Resources |
69% natural gas 59% oi |
39% natural gas 17% oil |
None | None |
| Breitburn Energy Partners |
74% natural gas 70% oil |
50% natural gas 42% oil |
18% natural gas 4% oil |
9% natural gas 3% oil |
| LINN Energy |
100% natural gas 70% oil |
100% natural gas\ 25% oil |
19% natural gas 0% oil |
None |
Data source: Company press releases.
Considering that the company recently sold its 2018 and 2019 hedging positions, it seems to be OK with having a slightly more aggressive portfolio. Chances are, the prices for oil and gas in 2018-2019 are going to be higher than the prices at which hedges are going for today, so better to leave future production open for the time being. If prices do rise before then and the company can lock in some favorable hedges, then you can probably assume that management will do so.
What a Fool believes
These are some tough times to be a oil and gas producer, but Vanguard is making the best of it. The deals for LRR Energy and Eagle Rock will help give the company a needed cash flow boost, and the stock deals prevented the company from taking on too much additional debt. A key component to Vanguard's success is its ability to continually make these kinds of deals, even in lower price environments. If it can make similar acquisitions in the future without stretching its finances too thin, then it should be able to get through this rough patch without investors suffering too much more than they already have.
