Memorial's Heightened Guidance Means A Locked-In 10% Yield

Memorial Production Partners (MEMP) is an upstream Master Limited Partnership, or MLP. Memorial is the primary recipient of dropdown acreage from its privately-held parent company, Memorial Resource Development and that company's private equity capital parent, Natural Gas Partners. With over a trillion cfe in reserves, most of it already proven, Memorial Resource Development drops mature, high-margin assets to the MLP, Memorial Production Partners, which I will just refer to as Memorial in this article.

Memorial's yield is currently among the highest in the upstream MLP space at just over 10%. Much of this low valuation and high yield is because Memorial is still a fairly young parnership. But just because Memorial is young doesn't mean that its dividend is unstable. In fact, management expects Memorial to cover its generous distribution by at least 1.10 times this year, which makes Memorial's distribution one of the more well-covered in the upstream MLP space. The good news is, thanks to a flurry of accretive dropdown acquisitions in 2013, Memorial has come out with strong guidance for 2014 which includes higher production, and even more importantly, higher distribution coverage. This higher coverage coupled with Memorial's extensive hedging policy, make Memorial's 10% distribution yield among the safest in this space. This article will focus on Memorial's expected 2013 results and guidance for 2014. As always, this article will also focus on Memorial's valuation and compare that valuation to that of other upstream MLPs.

2013 Parental Dropdowns

Operationally and financially, Memorial has had a good 2013, with a number of very important acquisitions, good distribution growth and solid distribution coverage. Last year the partnership made three acquisitions for over 400 billion cfe. This brings the partnership's total reserves to just over a trillion cfe. Last year's acquisitions were primarily of core acreage previously belonging to the parent company. This includes large acquisitions in the Cotton Valley of east Texas, one of America's oldest and highest margin gas fields. Memorial's other acquisitions in both the Permian and the Rockies helped the partnership achieve some much-needed liquids diversification. Memorial's reserve base has gone from almost 90% dry gas to only 59%, the remainder of reserves now 25% oil and 16% natural gas liquids.

Results & Guidance

Memorial produced 48 billion cfe in 2013. The partnership earned $208 million in EBITDA, $130 million of which was considered distributable cash flow. Thanks to last year's acquisitions, both production and distributable cash flow are expected to grow nicely. In 2014, annual production will grow by over 20%. Distributable cash flow will grow by 21% in the same period, conservatively. Perhaps best of all, distributable cash flow is expected to be at least 1.15 times distributions, making Memorial's distribution one of the most well-covered amongst upstream MLPs.

Hedging

Memorial's already secure distribution is made even safer by the company's extensive hedging policy, the conservatism of which is exceeded only by Linn Energy. As the chart above shows, dry gas, which makes up the majority of Memorial's production, is hedged at over 50% of its production to 2019. Over 80% of all gas production for this year is hedged. Interestingly, a majority of oil production is hedged until 2018. Usually oil production is more costly to hedge. When coupled with heightened DCF guidance, Memorial's hedging policy virtually ensures that the partnership's generous 10% yield will be covered. Many investors consider a 10% yield or greater to be a "red flag," but doing so in this case would be a mistake.

If Rates Keep Climbing

Memorial's debt sits at 2.37 times next year's expected EBITDA. That ratio may increase if Memorial continues making acquisitions. Of the company's approximately $492 million in debt, 400 million of it is in a fixed, 7.625% note which comes due in 2021. The other $90 million is on a $1 billion credit facility which does have a variable rate. While it is unknown how much additional debt Memorial may take on in order to do more acquisitions, I believe management will continue to be conservative and will continue to lean towards fixed-rate debt. In terms of party interest, management is independent from the parent company, which is another reason to believe that management will be measured and conservative with debt. That being said, this is a highly acquisitive time in the upstream MLP space, and Memorial will likely continue to participate in this activity.

Long-Term Future

At 2014 production rates, the partnership has 16 years worth of production. This assumes that Memorial will make no further acquisitions. But if the inventory of the partnership's parent company is any indication, Memorial will likely make a number of acquisitions in the coming years. The parent company has 500,000 gross acres and over 1 trillion cfe in reserves. Seventy percent of these reserves are natural gas.

Valuation for MEMP based on 2014 low-end DCF guidance. All others based on 2013 full-year expected DCF.

Considering all this, barring an existential event, I believe that Memorial can chug along at this rate for two decades, so long as the natural gas story in America remains viable. When considering valuations, Memorial looks even better. For example, based on low-end guidance, Memorial trades at only 8.4 times this year's DCF. This makes Memorial one of the best values in the upstream MLP space at the moment.

Conclusion

There's a lot to like about Memorial right now. It has among the lowest valuation and the highest distribution yield among its peers. And thanks to a series of accretive acquisitions last year, Memorial is now expected to boost DCF coverage in 2014, making the distribution a very safe one. While many will categorically dismiss any stock that yields 10% or more, usually on concerns of the safety of the said dividend, that would be a mistake here. Memorial is a conservative partnership with a deep, high-margin asset base. While much of the market has seen valuations run up in the past couple of weeks, in my opinion Memorial can still be bought right here.

Source: Memorial's Heightened Guidance Means A Locked-In 10% Yield

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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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