The Q4 2013 Vanguard Natural Resources Miss Was Highly Misleading, It's Still Looking Good

Vanguard Natural Resources (VNR) is an energy limited liability company, which acts as a limited partnership for tax purposes (effectively an energy MLP without any IDRs or GP interest). You will have to file a K-1 for VNR. It acquires and develops mature, long-lived oil and natural gas properties. It attempts to generate stable cash flows that allow for monthly distributions to its unit holders. It attempts to increase its monthly cash distributions over time. Since its IPO (about 5 years ago) it has grown its distribution/dividend about 46%. The current dividend is $2.49 annually (or about 8.2%). VNR's properties are located in the Permian Basin in West Texas and New Mexico, the Piceance Basin in Colorado, the WindRiver Basin in Wyoming, the Pinedale/Jonah fields in the Green River Basin in Wyoming, the Powder River Basin in Wyoming, the Big Horn Basin in Wyoming and Montana, the Arkoma Basin in Arkansas and Oklahoma, the Williston Basin in North Dakota and Montana, and acreage in Mississippi and South Texas.

Some have harped on the miss on adjusted Net Income of $0.14 per share available to common and Class B unitholders. On average analysts had expected adjusted Net Income of $0.31 per common and Class B unitholders. This may seem bad, but the reality is that the adjusted net income metric is not the best one to use for an energy MLP company (or LLC pretending to be an MLP). Instead Adjusted EBITDA, Distributable Cash Flow, and production numbers are more useful metrics.

Adjusted EBITDA was up 12% to $74.3 million for Q4 2013 year over year; but it was down sequentially from the Q3 2013 level of $82.7 million. Distributable Cash Flow available to common and class B unitholders was $42.7 million in Q4 2013 versus the year ago figure of $41.2 million. Again this was a decrease of 19% from the Q3 2013 result. Average production was 36,903 Boe/d for Q4 2013. This was a 62% year over year improvement; but it was only 5% higher than the Q3 2013 production of 35,250 Boe/d. However, VNR did have an excuse for the lesser growth from Q3 to Q4 2013. It experienced downtime in both November and December due to severe winter weather. That and infrastructure issues negatively impacted VNR's operations in the Permian basin, Arkoma, and the Rockies. This had a -1% impact on Q4 production. This amounted to 8000 barrels of oil and 127 Mcf of natural gas during Q4 2013. This may have skewed percentages slightly, but they were 64% natural gas, 24% oil, and 12% NGLS (natural gas liquids). Also the curtailed production continued into January 2014. Hence it will have a slightly negative effect on Q1 2014 earnings.

The good news is that the Pinedale/Jonah deal completed on January 31, 2014. This added 847 Bcfe of proved reserves, using internal estimates of Anadarko Petroleum (APC). Using SEC pricing of $3.67/mmbtu for natural gas and $96.90 per barrel for oil, these added proved reserves amount to only 765 Bcfe. Approximately 45% of the reserves are proved developed and 55% proved undeveloped. This 87,000 gross acres (14,000 net acres) are currently producing about 113.4 Mmcfe/d; and they are expected to be immediately accretive to cash flow. This last is a very good thing because VNR had a distribution coverage ratio of only 0.88x -- not enough to fully cover the distribution for Q4 2013.

With the new production from the Pinedale/Jonah acquisition, VNR FY2014 production metrics will improve significantly (see table below).

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As readers can see the midpoint of the FY2014 production guidance is 53,550 Boe/d which is almost 51% higher than the FY2013 production level. Admittedly a lot of the new production is less lucrative natural gas; but the new production still raises the metrics associated with cash flow (see table below).

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Most importantly the new production will raise the mid-point distribution coverage ratio to 1.12x for FY2014. Notice also that the estimated Nymex natural gas price for Q2-Q4 2014 is forecast to be $4.78/mmbtu. This is much higher than the $3.66/mmbtu average Nymex price in FY2013. The average differential is still high at roughly -$1.18/mmbtu for FY2014; but that was the differential for FY2013 too. There should be a lot more natural gas production; and there should be a lot more revenue from each mmbtu of natural gas (about +45% more realized revenue after subtracting the differential). This makes the expected results very believable; and it makes VNR with a sustainable 8.2% distribution/dividend a good buy.

Don't forget that the Pinedale/Jonah field deal added roughly 75% (using SEC figures) to VNR's proved reserves total. Don't forget that those proved reserves were bought for a much smaller fraction of VNR's enterprise value ($581 versus $3.34B) than the percentage they added. Don't forget that US natural gas prices are forecast to rise over the next few years. If you are looking for a better justification of that, please refer to the article, "The Cold Winter Weather Is Making Natural Gas The Hottest Commodity In The Market."

The two year chart of VNR provides some technical direction for this trade.

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The slow stochastic sub chart shows that VNR is overbought. The main chart shows that VNR is still trending slightly upward. This trend took a hit on earnings; but the earnings data are very misleading to the current situation. VNR deserves to continue going up; or at the least it deserves to go sideways. Don't forget VNR may make one or more good acquisition deals in FY2014 too. Don't forget that many experts believe US natural gas prices are headed higher over the next several years. Don't forget the distribution is going up to $2.52 annually as of the February 2014 monthly distribution ($0.21 monthly). This will raise the annual distribution/dividend to 8.3%.

With all this in mind, VNR is a buy. It has a mean analysts' recommendation of 1.9 (a buy). It has a CAPS rating of five stars (a strong buy). Investors should be able to sleep well at night with this strong, 8.2% dividend/distribution payer in their portfolios.

NOTE: Some of the fundamental financial information above is from Yahoo Finance.

Good Luck Trading.

Source: The Q4 2013 Vanguard Natural Resources Miss Was Highly Misleading, It's Still Looking Good

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VNR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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