Back in September I wrote an article on Memorial Production Partners (MEMP), which is a relatively new upstream MLP, or Master Limited Partnership. While Memorial has substantial prospects for future acquisitions from its parent organization and a good coverage ratio, at that time was trading at a relative premium to its upstream MLP peers. Also, in September Memorial's distribution yield was significantly lower than most. My recommendation at the time was to look at better value opportunities within the upstream MLP space.
That situation has since changed. Many of the bigger upstream MLPs, such as Linn Energy and BreitBurn have appreciated in price since September. And Memorial, for its part, has pulled back slightly. More importantly, the partnership's recent transaction has proven to be very accretive and is already adding to distributable cash flow. In short, Memorial's situation has improved while its price has actually declined a bit. Memorial Production Partners is now a solid buy and also represents an opportunity to build income in a meaningful way.
Acquisitions Have Added To Cash Flow
Memorial's acquisition has already been adding to the bottom line and has made the partnership a better value at its current price. As a young partnership, Memorial is still building its asset portfolio. Since April of 2012 the partnership has made seven transactions.
Its most recent acquisition has been the biggest. In July of this year, Memorial acquired from its parent company 275 billion cfe of proved gas reserves. Most of this was in east Texas, but some was in the Permian and the Rockies as well. Altogether this acquisition cost over $600 million.
This acquisition brought some liquids diversification to an otherwise gassy production profile: 90% of Permian acreage production is oil. These properties have already made a financial impact, adding significantly to distributable cash flow, or DCF. Original DCF guidance for the full year was originally $1.88 per unit. But with the contribution of these new properties we can expect $2.16 in DCF per share, even at the increased share count.
Before we get into valuation, Memorial has updated its hedge book and continues to lock in cash flow well into the future at minimal cost.
A majority of Memorial's natural gas production is hedged all the way out to 2019, with 87% hedged in 2014. Of its oil production, a majority is hedged out to 2018, which is quite impressive relative to many other MLPs. Eighty-two percent of 2014 oil production is hedged in at an average price of $93.95. All hedges are either collars or swaps, and so costs are minimal. Compared with its peers, Memorial's hedging policy is fairly conservative and forward looking.
Cost Structure A Competitive Advantage
Memorial's most significant base of operations is the Cotton Valley in east Texas, which is one of the oldest producing gas fields in the country. As a very mature field, Cotton Valley begets some of the lowest cost base and highest margins in the natural gas industry, and it shows in Memorial's numbers.
November 2013 Investor Presentation
While this chart may be an awkward comparison because a number of the above partnerships have a greater proportion of oil production than does Memorial, it still goes to show just how low Memorial's production costs are. A successful upstream MLP is one that has mature acreage where growth is slow but margins are high. As a partnership, Memorial is only 3 years old, but its low cost base should provide healthy margins for a good, long while.
A combination of increased DCF, appreciation in the unit price of its peers, and finally a lower price per unit have combined to make Memorial one of the best values in the upstream MLP space right now.
Figures based off 2013 DCF guidance for each respective MLP.
Price to DCF is one of my favorite ways to value an upstream MLP. While DCF is not a great measurement of earnings per se, I believe it is a good indicator of a partnership's ability to pay distributions, which is the most important consideration of most MLP investors. Based on this year's expected DCF, only Mid-Con Energy Partners (MCEP) trades at a lower ratio.
Patterns such as that displayed in the above chart are really what upstream MLP investors must look for. The yield has spiked as the distribution increased and the unit price has subsequently dropped. This chart indicates that a good time to buy Memorial is any time the dividend yield line spikes higher than the unit price line. Now is a good time.
As an upstream MLP, Memorial has a number of things going for it. It is primarily a producer of natural gas. Holding some of the oldest producing tight gas formations in the country, the partnership's cost of production and profit per barrel of gas are among the highest in the MLP space. Its distribution coverage continues to be in line with other upstream MLPs. Perhaps most importantly, Memorial's yield is among the highest in this space, and its price to DCF is close to the lowest. It would be tough to go wrong with Memorial right here.