Vanguard Natural Resources (VNR) is an energy limited liability company, which acts as a limited partnership for tax purposes (effectively it's an energy MLP without any IDRs or GP interest). It requires a K-1 at tax time. Its 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 8.6%). VNR's properties are located in the Permian Basin in West Texas and New Mexico, the Big Horn Basin in Wyoming and Montana, the Arkoma Basin in Arkansas and Oklahoma, the Williston in North Dakota and Montana, Mississippi, and South Texas.
VNR has about 175 MMBoe in proved reserves. These are about 60% natural gas and about 40% liquids. 70% are proved developed. In Q3 2013, production was even more skewed with 64% natural gas, 24% oil, and 12% NGLs. Even with this preponderance of natural gas VNR derived only 25% of its revenues from natural gas. It derived 64% of its revenues from oil. That is why it is great news for VNR that the price of natural gas has been going up recently. Nymex natural gas futures closed on December 26, 2013 at $4.433/mmbtu on the Nymex. This is up from a Q4 2013 low of $3.379/mmbtu on November 5, 2013.
These natural gas prices are better than recent ones, but they are still low by historical standards. The colder than normal winter this year seems likely to make them go up even more. If you look at the chart below of the Henry Hub Spot Prices for natural gas during a normal winter, you can see that US natural gas prices rose all winter (until mid-April 2013).
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The climb amounted to roughly $1/mmbtu from the approximate price in December 2012. This winter is predicted to be colder than last year's winter by the Farmers' Almanac; and so far it has been. If this colder winter results in a +$1/mmbtu rise in prices, they should reach about $5.40/mmbtu by mid-April of 2014. This would be great for VNR's earnings. It would also be great for VNR's reserves. They would likely be significantly revised upward in 2014. The value of the reserves (and to a large extent the reserves themselves) are computed based on a 12-month rolling average of the natural gas prices. With prices approximately +$1 in 2014, VNR would get a large revision upward in natural gas reserves (i.e. in book value and GAAP earnings). Since natural gas reserves are approximately 60% of total reserves, this would amount to a large increase in total reserves. This would be achieved with virtually no action on VNR's part. Plus VNR would also still get all of its other growth, which has been substantial historically (see the charts below).
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When you consider this, the investment risk/reward ratio for VNR becomes much more attractive. The price of the stock becomes much more likely to climb toward the end of 2014 and beyond.
Some may argue that one should not base one's investments on one cold winter. However, investors would not be doing that. VNR put together the table below of pluses for natural gas.
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This looks promising for the long term for natural gas. However, this table is a likely serious underestimate of the longer term growth in natural gas demand. It barely scratches the surface of the US LNG (liquefied natural gas) export demand over the longer term. The following table shows a more comprehensive list of the expected LNG export demand.
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This table shows the US LNG export facilities under construction and in the planning phase. 15.2 Bcf/d - 17.2 Bcf/d of new export capacity is expected to be in operation by 2020. 33.1 Bcf/d - 35.1 Bcf/d of new export capacity is expected to be in operation by 2026. This should provide sustained US natural gas demand growth for many years.
In addition to the LNG exports, the US is also planning to export more natural gas via pipelines to Mexico. A Barclay's report estimates that exports to Mexico will increase from 2 Bcf/d in 2013, to 2.2 Bcf/d in 2014, to 3.5 Bcf/d in 2015, to 4.5 Bcf/d in 2016; and the growth in demand is not expected to stop there. Earlier in 2013 Goldman Sachs forecast a jump in export capacity to Mexico to 4.8 Bcf/d by 2015. Splitting the difference, this likely means another 2+ Bcf/d in US natural gas exports by sometime in 2015; and it is already virtually 2014 now (December 26, 2013). The VNR table has not even mentioned this as a new source of natural gas demand.
VNR's table also cites a likely increase in demand for CNG (compressed natural gas) and GTL (gas to liquids) of a total of 3.1 Bcf/d by 2018. However, this is under the present set of circumstances. If the US Congress ever passes a Natural Gas For Transportation Act, which is something it has attempted to pass in the past, this could spur a huge ramp up in US natural gas demand in a very short time. The power of the US government would then be behind the ramp up.
On top of all this, the recent economic news has been good to great. Energy is highly cyclical, when economies heat up, they use more of it. The Fed started its tapering in a very mild way by buying $10B fewer bonds starting in January 2014. That means it will still be buying $75B in bonds per month. On top of that the Fed said that it would not necessarily start raising rates as soon as the US unemployment rate hits 6.5%. Many took this to mean that the fed will keep its main borrowing rate at 0 to 0.25% well into 2016. At the very least there does not seem to be any worry that low Fed rates will disappear soon. Almost unnoticed, the US Q3 GDP growth estimate was raised to +4.1%, which is nothing short of stupendous in the backdrop of recent US economic history. The official Chinese PMI for November 2013 came in better than expected at 51.4. The Euro Area manufacturing PMI (52.7) and the flash PMI (52.1) beat expectations. All this (and many other data points) effectively gave the green light to a Christmas rally. VNR could be a beneficiary; and if not, it still pays a great dividend. In the face of all of the above the stock price downside probability should be limited.
Even without all of the above positive fundamentals, VNR has been doing well. In Q3 2013 adjusted EBITDA increased 25% year over year to $82.7 million. Distributable cash flow to common and class B unitholders increased 44% to $52.9 million year over year. Average production in Q3 2013 was up 45% to 35,250 Boe/d year over year. Including hedges, VNR realized an average natural gas price of $3.48/mcf compared to $2.47/mcf in Q3 2012. If VNR sees the same level of rise in average natural gas price obtained in Q3 2014, that will be very good for its business; and there is substantial evidence that makes that likely. I note VNR is 86% hedged for natural gas at an average price of $4.55/mmbtu for FY2014 as of September 30, 2013; but remember VNR should benefit substantially with regard to reserve write "ups" in 2014 if prices continue to rise (see above explanation)
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 near overbought territory. The main chart shows that VNR has been consolidating sideways for the last two years. This could go on, or the current base could provide technical energy for a move upward. The fundamentals cited above indicate the a move upward from this point is much more likely than a move downward. The technicals substantiate this view.
VNR has an mean analysts' recommendation of 1.9 (a buy). It has a CAPS rating of four stars (a buy). The fundamentals and the technicals are both positive. VNR even has +5.3% insider buying over the last six months. It also has positive institution buying. The stars are aligned. VNR is a buy.
NOTE: Some of the fundamental fiscal data above is from Yahoo Finance.
Good Luck Trading.
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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