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Will Vanguard Natural Resources, LLC Sink or Swim?

By Matthew DiLallo - Mar 15, 2016 at 4:05PM

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The upstream MLP's fate lies in the ability of its rival to survive and its ability to sell assets to pay down debt.

Image source: LINN Energy LLC.

Over the past year, units of Vanguard Natural Resources (NASDAQ: VNR) are down a gut-wrenching 85%. That's due to a number of factors including persistently weak commodity prices, the company's leverage, and credit concerns within the industry. These issues could sink it into bankruptcy if it doesn't move quickly to address its issues to stay afloat, which still might not be enough.

What to do to stay afloat
At the moment, the most pressing near-term concern for Vanguard Natural Resources is its credit facility. As of the end of last year, it had borrowed $1.69 billion of its $1.8 billion borrowing base, leaving it with very little liquidity. Worse yet, that borrowing base is scheduled to be redetermined by its banks this April, with it likely being lowered by a significant amount because it is based on the value of its oil and gas reserves, which have fallen alongside commodity prices. In order to stay afloat, the company's banks can't cut the borrowing base below what Vanguard Natural Resources currently owes or it would be required to pay back the difference in a short amount of time.

One step the company is taking to mitigate a liquidity crunch is to monetize its SCOOP/STACK assets in Oklahoma. It is one of the few shale plays getting any attention today because the returns are still compelling at current commodity prices. A successful sale at a premium valuation could buy some much-needed breathing room.

In addition, the fate of upstream MLP leader LINN Energy (LINEQ) could also play a role in Vanguard Natural Resources ability to survive. LINN Energy is currently under significant financial stress because it too has pretty much maxed out its credit facility. The company is currently undergoing a strategic review of its capital structure that could lay out a blueprint that Vanguard Natural Resources and other upstream MLPs could copy. If LINN Energy successfully navigates through its own deep challenges, that alone could keep Vanguard Natural Resources afloat because it would have a president to follow.

This could cause it to sink
Conversely, if LINN Energy goes under, it could take Vanguard Natural Resources and the rest of the sector down with it. That's because both companies have similar issues, including virtually maxed-out credit facilities as well as the structural issues of being upstream MLPs. It's a case where the smaller Vanguard might not have any choice but to follow the sector leader into bankruptcy if that's where LINN Energy ends up.

Another potential pitfall for Vanguard Natural Resources is the sale of its SCOOP/STACK assets. It's not the only deeply indebted driller seeking to cash in on these assets, with Chesapeake Energy (CHKA.Q) and others also rumored to be putting STACK and/or SCOOP assets up for sale. However, with a growing number of sellers and a dwindling number of potential buyers because of the industry's credit issues, Vanguard Natural Resources' sale might not bring in as much as it had hoped, which could leave it short of the cash it was seeking to pay down its credit facility. That's clearly possible when looking at what Chesapeake Energy might fetch for its STACK assets, with the value pegged anywhere from $300 million to $700 million. Suffice it to say, given their balance sheet woes, both Vanguard Natural Resources and Chesapeake Energy need to sell these assets at high-end prices in order to make a meaningful impact on their overall debt situation.

Investor takeaway
Vanguard Natural Resources believes it has a plan to stay afloat this year, which is to cash in on its STACK/SCOOP assets and use that cash, plus internally generated cash flow from oil and gas production, to pay down its credit facility. Having said that, it might not be enough, especially if upstream MLP leader LINN Energy or another big energy company like Chesapeake Energy goes under because it could pull smaller oil and gas companies like Vanguard Natural Resources down with it. In other words, its ability to stay above water isn't entirely in its own hands right now, which is a dangerous place to be.

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