Investors in Vanguard Natural Resources (VNR) are digesting yet another acquisition, a very sizable one this time. Vanguard will spend nearly $600 million, or a quarter of its current market capitalization, to acquire oil and gas assets in Wyoming in a deal significantly adding to current production and reserves.
The monthly distributions, which provide investors with a very high annualized dividend return is the key attraction for investing in Vanguard Natural Resources.
A Look At The Acquisition
Vanguard Natural Resources announced that it has entered into a definitive agreement to acquire natural gas and oil properties in the Pinedale and Jonah fields in Wyoming.
Vanguard will pay $581 million for the acquired assets, which consist of 87,000 gross acres and 14,000 net acres, producing 113.4 Mmcfe per day. The vast majority of production is natural gas, around 80%. Oil represents just 4% of production with natural gas liquids production making up the remainder.
CEO Scott Smith commented on the rationale behind the deal, "Acquiring an interest in one of the country's most prolific natural gas fields, operated by companies with an unparalleled history of successful development, is a milestone event for Vanguard. At closing, our reserves and daily production will increase approximately 80% and 55% respectively, and we will add an inventory of approximately 970 proved undeveloped drilling locations."
The acquired properties mark a transition in Vanguard's traditional setup. Rather than maintaining production, the deal allows for growth, and therefore fits perfectly within its 2014 acquisition program.
The acquired activities have an estimated reserve life of 20 years, which is based on internal reserve estimates of 847 Bcfe. The deal includes 2,000 producing wells and 970 proved undeveloped drilling locations. There are furthermore 5,200 other drilling locations identified which are not recognized under SEC regulations yet.
To hedge expected cash flows, Vanguard expects to hedge expected gas and oil production through 2017. The deal is expected to close in January of 2014.
Financial Performance & Balance Sheet
In October, Vanguard Natural Resources released the results over the third quarter. The company ended the quarter with a mere $7.4 million in cash and equivalents, resulting in a net debt position of about $950 million. The leverage incurred from the announced acquisition comes on top of this, and will be financed with borrowings under the existing credit facility.
Revenues for the first three quarters of the year came in at $346.5 million, up 46.5% on the year before. Income available to shareholders rose by 71.3% to $56.0 million. Note that earnings are depressed to quite an extent given the $60 million in annual interest payments at the moment. The reported deal could increase the interest expense tag to roughly $100 million per annum.
Full year revenues could come in around $450-$500 million as earnings could come in around $75 million, once annualizing the results for the first nine months of the year. More importantly, coverage ratios which are crucial for the dividend payments continue to exceed 1.
Trading at $29 per share, Vanguard Natural's equity is valued at $2.3 billion. This values equity in the business at 4.8 times annual revenues and 30-31 times annual earnings. Note that earnings ratios are not of a prime concern for shareholders, who care more about the ability to sustain the large dividends.
The monthly distribution of $0.2075 per share provides investors with an annualized dividend yield of 8.6% which is obviously very attractive in today's low interest rate environment.
A Look Into Vanguard's Past Performance
After trading as low as $5 in 2008, shares of Vanguard Natural Resources have traded in a $20-$30 trading range since 2010.
On top of the aggressive high dividend policy, shares have risen some 12% year to date.
Implications For Investors
Vanguard Natural Resources has aggressively expanded its operations through acquisitions in recent years. This well-disciplined growth has been accompanied by distribution growth as leverage checks remain in place.
In recent years some 18 companies have been acquired for nearly $3 billion, and last week's announcement is a sizable addition to this list. As such, full year production growth in 2013 is expected to grow by roughly 90%. This deal will boost production growth by another 55% going forward, marking the fast growth at the moment.
The company aims to develop and grow a diversified and well-balanced portfolio with developed assets. Typically the company screens many acquisition targets every year, but only picks those companies or assets with low capital requirements, proven and developed reserves. Targeted production lives are long with shallow declines being expected. Combined with an active hedge policy, the company then aims to lock in the "margins" providing relatively little risky cash flows to its investors.
This much lower risk approach creates a very stable share price, something desirable if you invest for dividend income alone. This avoided a similar attack or volatile price performance which other master limited partnerships like Linn Energy LLC (LINE) have seen this summer.
After the latest deal, Vanguard has levered up enough for the short term, although further acquisitions will undoubtedly follow next year, except that I suspect they would be smaller in size. Yet price moves will largely insulate Vanguard from price moves going forward. This is after the company hedged 85% of expected production in the years forward. In fact high natural prices could result in supplier inflation, and actually harm Vanguard's performance with hedge ratios approaching a 100%.
For now the market seems to be pretty happy with the risk-averse, disciplined, yet aggressive growth of the business. I therefore have to conclude that shares look very appealing, especially to dividend-oriented investors.