Vanguard Natural Resources LLC (VNR) is a limited liability company that chooses to be taxed as an MLP. However, it has no dilutive general partner and no IDRs. The company is focused on the acquisition and development of mature, long-lived oil and natural gas resources. VNR attempts to generate stable cash flows that it can distribute monthly to its shareholders/unitholders. It attempts to grow its dividend/distribution over time. The dividend has grown 43% since 2007; and it is currently $2.43 per year (8.78%). The company claims a growth from 1,935 Boepd in 2007 to 33,900 Boepd at 2013E (1,652%). Given that VNR had already reached 24,367 Boepd by the end of Q3 2012, its target of 33,900 Boepd seems easily within reach. It has grown proved reserves of 11 million Boe in 2007 to 138.6 million Boe at the end of Q3 2012. These consisted of 62.7 million barrels of crude oil, condensate, and NGLS, and 455.4 Bcf of natural gas (55% of total proved reserves).
If you look at the recent purchases (see the chart of capital spending below), you can see that VNR bought oil when it was available at reasonable prices after the recession. Now it is buying more natural gas as natural gas has recently hit a ten year historical low.
This buying pattern involves some risk. It could be that natural gas prices will take a long time to recover. VNR has said it doesn't want to drill for any more natural gas than it has to until natural gas prices rise to the $4.50/Mcf level or higher. However, this is the strategy Warren Buffett has followed successfully for years -- "buy when there is blood in the streets." This strategy seems as likely to work well for VNR as it has over the years for Warren Buffett.
Natural gas has already started to displace coal in electrical power generation. Many predict that this process will continue; and it will mean more natural gas use in the US. The first US LNG export terminal from Cheniere Energy (LNG) is scheduled to go online in 2015. Many more are scheduled to follow it. LNG exports will help push the price of natural gas up both on a supply/demand basis and on a market psychology basis. On top of this, the US is slowly moving to adopt natural gas a substitute fuel for gasoline and diesel fuels. Some companies such as Westport Innovations (WPRT) are building natural gas motors for large trucks. Others companies such as Clean Energy Fuels Corp. (CLNE) and Chesapeake Energy (CHK) are building CNG (compressed natural gas) and LNG (liquefied natural gas) refueling stations in the US. Many city transit organizations are converting over to natural gas as a cleaner and cheaper fuel than either diesel or gasoline. Congress has considered, although it has not yet approved, a natural gas for transportation bill. The totality of the natural gas use in areas other than heating and power generation is growing slowly now, but it should gain momentum over time, especially if oil prices go up dramatically. In this last vein, Chinese oil imports were up 7.7% year over year in December 2012 to 10.58 million barrels per day; and China is only one of many emerging economies. Further the US wants to wean itself off Middle East oil imports; and it wants to become energy independent. These are all good reasons to expect natural gas use in the US to increase in the future. Such increases should buoy prices. It makes a lot of sense for VNR to position itself to take advantage of these likely future increases in natural gas prices. VNR is taking the long-term view. This seems to be a fundamentally sound approach.
If this has you interested, you naturally want to know how the company is doing financially. The company actually seems to be doing well. It had production of 24,367 Boepd in Q3 2012 versus 13,371 Boepd in Q3 2011. It had adjusted EBITDA attributable to unit holders of $66,277,000 in Q3 2012 versus $37,028,000 in Q3 2011. It had distributable cash flow of $36,640,000 in Q3 2012 versus $19,029,000 in Q3 2011. On a per unit basis, that growth was much less at $0.67per unit in Q3 2012 versus $0.63 per unit in Q3 2011; but there was still growth.
One thing that needs to be explained is that VNR reported a net loss of $68.7 million or ($1.29) per basic share compared to a net income of $75.9 million (or $2.51 per basic share) in Q3 2011. Q3 2012 includes a loss of $86.7 million in non-cash adjustments, while Q3 2011 included a gain of $106.9 million in non-cash adjustments. Excluding these items, adjusted net income attributable to unit holders was $17.9 million in Q3 2012 (or $0.34 per basic unit) versus $14.1 million (or $0.47 per basic unit) in Q3 2011.
Two items factored heavily into these figures. First VNR reported a ($51,332,000) unrealized loss on commodity derivative contracts. This was largely due to the loss in value of natural gas hedges as the price of natural gas rose from its low in Q2 2012 to a much higher average in Q3 2012. As you can gather, this does not reflect weakness in the company. Still the natural gas hedges were worth less as the price of natural gas rose. A second factor was a big write down in the value of natural gas assets due to the rolling 12 month average price of natural gas. This also does not reflect long-term weakness. In fact VNR will likely be in line for some write-ups in late 2013.
The above is a big reason you cannot pay too much attention in the short-term GAAP net income losses in this kind of company. The actual good results for one quarter (or sometimes more than one quarter) can be swamped out by the non-realized hedging losses as the company is hedged for many years into the future. Further write-downs on assets are often temporary. It is better to pay attention to the Distributable Cash Flow increase of 93% to $36.6 million from $19.0 million in the year ago quarter. It is better to pay attention to the adjusted EBITDA increase of 79% to $66.3 million over that of Q3 2011. It is better to pay attention to the 82% gain in production year over year on a Boe basis. All told VNR looked healthy in Q3 2012. The fact that the results were in many ways ugly from an accounting standpoint can be explained satisfactorily. Instead of making you not buy the company, you should realize that the losses are accounting artifacts of unusual market conditions.
Many experts believe the cost of natural gas will continue to go upward longer term. VNR should be a healthy company for many years to come. These accounting artifacts are giving the astute investor the chance to buy a great company at a reduced price. Astute investors will take advantage of this. The VNR production breakout for Q3 was 30% crude oil, 61% natural gas, and 9% NGLs on a BOE basis. VNR does have significant oil production. However, it will do much better as the price of natural gas rises. Over the longer term, the EIA is predicting a strong steady uptrend in natural gas prices (see the chart below). This is not surprising since virtually everyone is predicting secular growth in energy due to emerging market economic growth.
Now is likely a great time to buy VNR as a long-term play on energy. It pays a great 8.78% dividend that will help you wait for the more prosperous times. It appears to have seen the worst with the Q2 2012 low in natural gas prices. Its performance should improve from here. Plus its management team is following the long-term Warren Buffett strategy of buying when there is blood in the streets. One has to admire their courage and their energy acumen. VNR is a buy.
As a safeguard, VNR does have significant hedges (see chart below).
The two year chart of VNR provides some technical direction for this trade.
The slow stochastic sub chart indicates that VNR is near oversold levels. It can be bought. The main chart indicates that VNR is in a long-term consolidation phase. It looks like it is about to bounce off its 50-day SMA and its 200-day SMA. The 50-day SMA appears to be ready to push upward through its 200-day SMA. I wouldn't expect VNR to be a really exciting growth stock until we get nearer to 2015. Then US natural gas prices are likely to surge upward a bit. Still the 8.78% dividend is reason enough to buy this with a long-term strategy.
In 2015 and beyond, LNG exports should help to bring lower US prices more in line with higher world prices. Of course, there is no saying when the stock will start to rise. It could suffer a near term fall in stock price if the US has a recession in 2013. However, as long as you are prepared to collect the 8.78% dividend while you wait for the secular energy growth, you should not have a problem. VNR's recent sale of 9,200,000 common units for proceeds of $246.1 million after deducting costs should help keep it in good stead with its creditors.
VNR has an FPE of 18.61, which is quite reasonable considering the currently depressed natural gas prices. The management team is sharp; and the value is there. VNR is a buy to this analyst. Further the average analyst recommendation is 1.8 (a buy); and the CAPS rating is five stars (a strong buy). You can't go too far wrong with VNR in the long term, but do be prepared to wait for this one. Also averaging in over the course of 2013 should be a good strategy. The economic situation both in the US and worldwide is very tenuous. Averaging in will help you ensure that you will get a good entry price for this great dividend payer.
NOTE: Some of the fundamental financial data is from Yahoo Finance.
Good Luck Trading.